Most savvy home loan shoppers are familiar with the requirement to obtain private mortgage insurance, or PMI, when the down payment on the note is less than 20% of the assessed value of the property. The primary purpose of the insurance is to help protect the lender in the event the loan goes into default. Although PMI results in a higher monthly mortgage payment, it does allow consumers to purchase a home without having to provide a significant amount of capital up-front (which can take a number of years to save up depending on the individual). A lesser known alternative to PMI, is LPMI, or lender paid mortgage insurance that allows one to avoid having to pay monthly private mortgage insurance.
How Does LPMI Work?
Lender paid mortgage insurance is a bit of a misnomer, as the home buyer will still be paying for the insurance premium; albeit under a different name. There are several variants of LPMI in use in the current mortgage marketplace. These include paying a lump sum up-front in the life of the loan for the insurance, making an adjustment to the mortgage rate, or making larger mortgage payments every month.
If lender paid mortgage insurance is paid via lump sum, the lender will provide the amount that has to be paid to cover the expected costs to obtain insurance on the loan. This amount will ultimately be based on the loan details of the property purchase. If you choose to pay LPMI over time, then the overall payment will come out in the form of a slightly higher mortgage interest rate. In some cases, it can be slightly cheaper for consumers who want to pay LPMI (when available) versus PMI but is worth validating before choosing either option from a lender.
Factors to Consider Before Electing to Pay LPMI
There are a number of factors to consider before electing to pay LPMI on a mortgage. First, not all lenders will make LPMI an option for consumers seeking out a home loan. Even if the bank or mortgage company offer lender paid mortgage insurance, most will require the person seeking out the home loan to have good to great credit for it to be an attractive enough of an option to consider.
For consumers who have to opportunity to consider LPMI, it is normally most attractive for those who have a higher income. This is due to a potentially greater tax break when selecting the higher interest option with LPMI (if the individual deducts home mortgage interest costs in the United States). Home shoppers that have lower incomes might find themselves in a position to be able to deduct standard private mortgage insurance so obtaining LPMI may not provide an additional tax break. Before choosing one option over another; however, it is highly recommended to seek out the advice of a tax professional before assuming that you understand the full tax implications of the insurance choice(s) made when obtaining the mortgage.
Is LPMI Better for Short or Long Term Mortgages?
Most mortgagors find lender paid mortgage insurance to be more advantageous on shorter term loans vice those who prefer the 30 year or longer traditional mortgage. This is due to the most prevalent LMPI options requiring a higher mortgage interest rate than one would normally qualify for while paying back the loan as compared to the less-frequently encountered lump-sum option. The increased rate will survive for the life of the loan which requires the consumer to pay off the note to fully get rid of the premium paid for LPMI. In this case, the other alternative to paying off LPMI is to refinance the loan once you have 20% or more equity invested in the home. This compares unfavorably to PMI which can be cancelled once there is sufficient equity in a property without having to refinance the note. Once PMI is removed, the mortgagor then enjoys the lower term interest rate for the life of the loan.
If the LTV (loan-to-value) ratio of the property is already close to 80%, most financial advisors will recommend against obtaining LPMI unless planning to unload the property or refinance in a short time-frame. If PMI is selected over LPMI, the insurance will be able to be paid off soon without being stuck with higher interest payments. Finally, if the housing market is strong or strongly recovering in the area of the country the home is being purchased, PMI may be able to be cancelled for the cost of a new home appraisal (several hundred dollars) in a relatively short timeframe.
What are the Alternatives to LPMI?
If lender paid private mortgage insurance does not sound like an attractive option to you , there are several alternatives when pursuing a new home loan. First, the obvious choice is that a down payment of at least 20% of the home loan can be made. For the average consumer, having this much money available to make a down payment on a home can be challenging if not impossible. One of the more popular alternatives is to choose private mortgage insurance (PMI) rather than LPMI.
A third option is to select an 80/20 loan, or piggyback loan if available from your mortgage lender. These are not as popular today as they were a number of years ago. In the 80/20 loan scheme, the mortgagor avoids any mortgage insurance by taking out a second loan or note to make up the 20% difference in equity in the home. The second loan is normally at a higher interest rate than the primary note with the theory being a consumer can pay it off more quickly than PMI. For all of these options, the consumer enjoys having a lower overall interest rate on the home loan than when taking out a loan that has a higher overall interest rate with LPMI.
Lender Paid Mortgage Insurance Example
For some mortgagors, taking a look at what the bottom-line looks like with and without LPMI makes more sense than reading a description about the insurance payment. A basic example follows:
Home and Mortgagor Specifics
$200,000 purchase price
10% down payment
750 credit score
30 Year fixed rate 4.875%
Home Loan Option 1 (Standing Mortgage Insurance)
Monthly Payment Example (not including taxes and homeowners insurance):
$971 Principal & Interest
$84 Monthly mortgage insurance
=$1055 Total payment
Home Loan Option 2 (Upfront LPMI Premium Paid)
Monthly Payment Example(not including taxes and homeowners insurance):
$971 Principal & Interest
Results in $84 monthly savings.
For a savings of $9504 over 10 years.
Home Loan Option 3 (LPMI with a higher interest rate of 5.25% in exchange for no monthly insurance payment)
$1013 Principal & Interest
Results in $42 monthly savings
What are the Disclosure Requirements for Lender Paid Mortgage Insurance?
Disclosure requirements for lender paid mortgage insurance (LPMI) are contained in U.S Code, § 4905. The law starts off with covering definitions first. These include:
Borrower paid mortgage insurance – Private mortgage insurance required for a residential mortgage transaction is paid for by the borrower of mortgage.
Lender paid mortgage insurance – Private mortgage insurance required for a residential mortgage transaction where the payments are made by someone other than the borrower.
Loan commitment – The written confirmation by the prospective mortgagee approving the applicable closing conditions for the pending residential loan.
Required LMPI Notices to the Mortgagor – When lender paid mortgage insurance is required for a residential mortgage transaction, the following notices are required by the lending company to the mortgagor:
– No later than the date that the loan commitment is made for the residential mortgage transaction, the mortgagee (prospective) will provide to the mortgagor ( the person getting the loan) a written notice stating:
– The lender paid mortgage insurance differs from traditional PMI (private mortgage insurance) by the lender provided insurance being able to be canceled only by the entity providing the loan and not the person taking out the loan (mortgagor) . Borrower paid mortgage insurance; however, can be canceled by the mortgagor (person taking out the loan) in accordance with section 4902 (section a) of the law and can legally conclude on the termination date in accordance with section 4902(b) of the law.
– Lender paid insurance will:
– Normally result in the mortgage having a higher overall interest rate than a traditional mortgage will have.
– Will only terminate when the residential mortgage is refinanced, paid off, or otherwise terminated, and:
– Lender paid mortgage insurance and borrower paid mortgage insurance each have goods and bads (or benefits and disadvantages), which include a generic analysis of the differing costs between the two options, benefits of the residential mortgage in the case that the lender paid the mortgage insurance versus what the borrower would pay over a 10 year period, and will assume prevailing property appreciation rates and insurance rates.
– Lender paid mortgage insurance (LPMI) can be tax-deductible for Federal income taxes if the borrower (mortgagor) itemizes their annual taxes to this purpose, and
– At a time frequency not later than 30 days after the termination date that PMI would apply, the service provider for the loan will provide a written notice that indicates the mortgagor will likely want to investigate options that can remove the requirement to pay private mortgage insurance in conjunction with the residential mortgage transaction.
Standard Forms – This section of the law allows the entity which services a residential mortgage to create and use a set of standardized forms to provide the notices to the person who has obtained the home loan (mortgagor) as required under the law. The one exclusion of this part of the law does not permit sections 4902 and 4904 to be applied if lender paid mortgage insurance is being paid.