Homebuyers have a variety of conventional mortgages to choose from. The element most have in common is private mortgage insurance—usually required when the down payment is less than 20% of the home’s value.
In some situations, a lender may arrange for PMI coverage. It then becomes known as lender-paid mortgage insurance. For some homebuyers, LPMI can work in their favor. But for others, having a lender secure private mortgage insurance can end up costing them.
Keep reading to understand LPMI and the pros and cons for a homebuyer.
How Does Lender-Paid Mortgage Insurance Work?
Unless 20% or more of a home’s value is paid upon closing, homebuyers can typically expect to be required to purchase PMI.
While government-back loans tend to have their own insurance programs (most FHA loans require a mortgage insurance premium for 11 years or the life of the loan), most loans not provided by the government with a loan-to-value ratio higher than 80% require PMI to protect the lender in case of default.
PMI is typically purchased in one of four ways. It can be paid:
• Along with monthly mortgage and insurance payments
• In one annual premium
• With one large payment and corresponding monthly payments
• By the mortgage lender in a LPMI policy
While it may seem that the last option, LPMI, eliminates a task on a homebuyer’s to-do list, there is some fine print to be aware of.
Having a lender pay the required PMI for a loan doesn’t mean the cost is absorbed by the lender. A homebuyer will still pay for the coverage in one of two ways:
• A one-time payment due at the beginning of a loan.
• A slightly higher interest rate, which increases the monthly mortgage payment. This is the more common arrangement of the two.
So while many homebuyers accept an LPMI arrangement in hopes of saving money, that isn’t automatically the case. Sometimes LPMI is more about convenience than savings.
In fact, unless paying a one-time lump sum, homebuyers could end up spending more for LPMI over the life of their loan than if they had chosen a traditional PMI route.
LPMI might be a good choice for a homebuyer planning to keep the mortgage for five to 10 years or stay in the home. It usually takes 11 years to build enough equity to cancel a borrower-paid PMI policy.
A Pro of LPMI
Before a homeowner writes off lender-paid mortgage insurance altogether, it’s best to look at a potential benefit the arrangement offers over traditional monthly mortgage insurance.
More Affordable Monthly Payment
With LPMI, the monthly payment could be more affordable because the cost of the PMI is spread out over the entire loan term rather than bunched into the first several years.
Here’s an example. If Sarah buys a home with a 10% down payment and it takes her 10 years to get the loan-to-value ratio down to 78% (a lender automatically drops PMI payments at this percentage if the borrower is in good standing), those 10 years of payments could all include several hundred dollars in addition to her premium and interest payments.
While LPMI may not save Sarah money overall, she may be able to enjoy smaller monthly payments as the additional payments for coverage are stretched out equally over the entire life of her loan rather than the start.
… and Potential Cons
In the right situation, LPMI can make sense. But there are potential downsides homebuyers should know about as well.
Rate Never Drops
While having mortgage insurance stretched out over the life of a loan can save some homebuyers money, it can cost others. The higher interest rate—a 0.25% rate increase is common—can never drop, even once the loan balance is less than 80% of a home’s purchase price.
LPMI can end up costing homebuyers more than if they had ventured out on their own. Much depends on how long the borrower expects to hold the mortgage.
Refi Costs
Some homebuyers navigate toward LPMI because of the initial savings and hope they can refinance in the future.
While this may be a possibility, they must consider the sizable out-of-pocket costs that go along with refinancing, and that refi rates may be higher in the coming years.
No Itemizing
LPMI can’t be itemized if you deduct mortgage interest at tax time.
PMI vs. LPMI
There are several numbers to take into consideration when choosing between traditional PMI and LPMI, including:
• the down payment
• remaining mortgage
• interest rate (for LPMI, a 0.25% rate increase is common)
• average mortgage insurance rate (PMI is typically 0.5% to 1.5% of the loan amount per year)
• anticipated life of the mortgage loan
• monthly budget.
A borrower may want to not only consider the monthly payment but also the lifetime loan costs.
The difference between PMI and LPMI is different for every homeowner and situation. Taking the time to crunch the numbers is the only way to fully understand the pros and cons of each option.
LPMI Alternatives
LPMI isn’t always the clear winner when choosing between mortgage insurance options. There are alternatives to consider.
Put More Down
A down payment of at least 20% will eliminate the need for PMI entirely. There are several other benefits that go along with larger down payments as well, making this a great option for those who can afford it.
Shop Around
One main disadvantage of LPMI is that the homeowner has little to no control over the price and provider. So when homeowners are responsible for their own PMI, shopping around for the best price becomes an option.
Piggyback Mortgage
A piggyback mortgage makes it possible to avoid PMI with a combination of loans.
It’s important to understand the pros and cons of a piggyback mortgage before deciding on one as an alternative to LPMI to avoid potential financial pitfalls.
The Takeaway
If mortgage insurance is necessary to secure a loan, understanding all the options is the first step any house hunter should take. This includes lender-paid mortgage insurance vs. PMI. While LPMI may serve as an overpriced convenience for some, it can be the financially smarter option for others.
A mortgage loan with SoFi can all be done online, giving homebuyers more time to focus on the details.
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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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