If you can’t put 20% down on a home, you’ll have to pay Private Mortgage Insurance. If the thought of paying yet another insurance makes your skin crawl, you can consider lender-paid mortgage insurance or LPMI. As the name suggests, the lender pays the insurance for you. What’s the tradeoff? Is it worth it? We take a look below.
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What is Mortgage Insurance?
First, let’s look at mortgage insurance. This policy covers the lender, not you, the borrower. If you were to stop making your payments, the lender is stuck with your home. They stand to lose a lot of money. When borrowers put down less than 20% on a home, the risk of this happening is high. In order to offset the risk, lenders require mortgage insurance.
You pay the insurance premiums, but the lender reaps the benefits. The insurance company pays the lender if you default on the loan.
How Does Lender-Paid Mortgage Insurance Work?
If you don’t want to pay the PMI mortgage insurance premiums, you can opt for lender-paid mortgage insurance. With LPMI, the lender pays the premium in one lump sum at your closing. However, there’s a tradeoff. You’ll likely pay a higher interest rate. Most lenders charge between 0.25% and 0.5% more to pay for your insurance.
What’s the Difference?
You might wonder what benefit there is if you opt for LPMI, you still pay more for the loan. With a higher rate, is it worth it to have the lender pay your mortgage insurance?
Let’s look at the two scenarios:
Let’s say you need a $150,000 loan. You are buying a home worth $160,000. Since you are not putting down 20%, you need Private Mortgage Insurance.
If you pay the PMI yourself, your payment would include principal and interest of $716 and PMI of around $111. This is a total payment of $827. The exact amount you pay for PMI depends on your credit and LTV. This amount is based on average credit.
If the lender pays the PMI, they may charge you a rate of 4.5%. Your payment would be just the principal and interest of $760. This is $67 less than if you paid the PMI even though you have a higher interest rate.
How do you Decide?
The bigger question is how do you decide between lender-paid mortgage insurance and borrower paid? It all comes down to your situation. Are you going to live in the home for the long-term? If so, taking a higher interest rate may not make sense. PMI is temporary. Once you hit less than an 80% LTV, it falls off your payment. You are then left with the lower interest rate.
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If you take the lender-paid mortgage insurance, your payment remains the same. You pay the higher interest over the life of the loan. Let’s look at the difference between the 4.0% and 4.5% over the life of the loan.
- 0% you pay a total of $107,804 in interest
- 5% you pay a total of $123,610 in interest
If you were to stay in the home for the entire 30 years, you’d pay $15,806 more in interest! Chances are you have something much better to do with $15,000.
Offsetting the Cost of LPMI
Luckily, there are ways to help you afford the higher cost of LPMI. First, you can negotiate with a lender. You don’t have to take the initial rate they quote you. Talk to the lender and see how much wiggle room they may have. You never know when they may bend and even lower the rate 0.25%.
If your negotiation skills are rusty, you can also pay a discount point or two to buy the rate down. This will cost you more upfront, but will give you the benefit of the lower interest rate over the life of the loan.
Some lenders also offer partial payments of the mortgage insurance. This way you meet the lender halfway, so to speak. They pay half of the insurance for you and you cover the remaining half in your monthly payments. This way you can obtain a slightly elevated, but not too high interest rate.
Of course, PMI isn’t your only option. If you don’t want to deal with it at all, you have options:
- Make a 20% down payment either with your own funds or gift funds (approved by the lender)
- Take a government-backed loan, such as a USDA or VA loan (the USDA loan does have mortgage insurance but it’s often less than conventional loans)
- Find a less expensive home
- Take subprime financing (lenders that make their own loans don’t charge insurance premiums)
Before you decide, look at the big picture. How much will the loan cost you over its entire life? What will the insurance cost you? Is the interest rate one you can afford? What is the APR for the loan? This is usually one of the most important factors you can consider. It looks at the full implication of the loan, not just the interest rate. This way you’ll know how much the loan will cost you over its entirety.
As you find the right loan for you, talk with different lenders. You may receive different interest rate quotes as well as PMI quotes. Some lenders won’t offer lender-paid mortgage insurance while others do but for a cost. Weigh your options and figure out which loan works right for you.