Mortgage Q&A: “What is lender-paid mortgage insurance?”
Earlier this month, a rule went into effect that made mortgage insurance permanent on many FHA loans for the entire life of the loan. Ouch!
Before this game-changer, FHA loans were the cat’s meow because of the low mortgage rates offered, coupled with mortgage insurance premiums that were not only more affordable, but removed once the loan amortized to 78% LTV.
But in an effort to reduce losses, the FHA had to end its easy money policies and clamp down on borrowers taking advantage of a program originally intended for the underserved.
Additionally, homeowners can request the removal of PMI at 80% LTV, or sooner if the home appreciates in value.
Okay, so a conventional loan with PMI probably sounds a lot better than an FHA loan at this point, and the lender will even pay for it?!
Lender-Paid Mortgage Insurance Isn’t Free
- The phrase “lender-paid” is deceiving/confusing
- Because while the lender may pay the premium on your behalf
- The borrower is the one who actually pays for it
- So don’t assume it’s free coverage
When you see the term “lender-paid mortgage insurance,” your first impression might be that the lender pays for it, and you don’t.
The reality is that the lender does indeed pay for the mortgage insurance (on your behalf), but so do you, in the form of a higher mortgage rate.
So instead of securing a rate of say 3.75% on your 30-year fixed, you agree to pay 4% with no mortgage insurance paid out-of-pocket.
This is similar to a no cost refinance, where the lender pays all the closing costs, but you wind up with a higher interest rate.
At the end of the day, there is no free lunch – excuse my pun, but it’s true.
Lender-Paid vs. Borrower-Paid Mortgage Insurance
Now let’s look at lender-paid vs. borrower-paid mortgage insurance to see how they stack up in the real world.
This is just one example to illustrate the difference, so do your own math with real numbers if and when it comes time to make this decision.
Loan amount = $100,000
Loan-to-value ratio = 90%
Monthly MI premium = $52
Option A (Borrower-Paid):
30-year fixed @3.75%
Monthly mortgage payment = $463.12 + $52 = $515.12
Option B (Lender-Paid):
30-year fixed @4%
Monthly mortgage payment = $477.42 + $0 = $477.42
As you can see, the option with lender-paid mortgage insurance is actually cheaper in terms of total monthly payment.
However, the borrower-paid option will eventually become cheaper once the mortgage insurance no longer needs to be paid.
But that’s only the case if you keep your home loan long enough to see that benefit. So how long you plan to keep the mortgage matters a lot as well.
Advantages of Lender-Paid Mortgage Insurance
- You don’t pay mortgage insurance directly
- May equate to a lower monthly housing payment
- May qualify for a larger loan amount
- Higher tax deduction possible
One of the biggest advantages of LPMI is that you don’t have to pay mortgage insurance premiums.
As we saw from the example, this can equate to a lower monthly mortgage payment in some cases, which is generally a good thing.
Of course, if you go with borrower-paid mortgage insurance (BPMI), your monthly mortgage payment will be lower once the mortgage insurance is no longer required.
So LPMI is generally only a money-saver if you don’t plan to stay in your home that long, or if think you may refinance sooner rather than later.
If you elect to go with LPMI, you may also be able to qualify for a larger loan amount (or purchase a more expensive home), seeing that the monthly payment can be lower.
A lower payment means a lower DTI ratio, which means you can get more loan for your income. While it may not be a huge difference, if things are close, the LPMI option could come in handy.
Another pro for LPMI is that there is the potential for a larger tax deduction, seeing that you’re paying a higher interest rate each month. It’s a bit counterintuitive, but it should still be mentioned – this was especially pertinent before mortgage insurance premiums became tax deductible in 2007.
Tip: For those who earn more than $100,000 annually, the deductibility of mortgage insurance begins to diminish after that point, making the argument for LPMI even stronger.
Disadvantages of Lender-Paid Mortgage Insurance
- You can’t cancel LPMI
- Since it is built-in to your mortgage rate
- It’s non-refundable
- Payment will be higher for the life of loan
The clear disadvantage to LPMI is that it cannot be canceled, ever. Kind of like FHA loans nowadays.
Because LPMI is built into the interest rate, it is there forever, or at least until you sell your home or refinance the loan.
In other words, your monthly payment will eventually be higher than the BPMI option, as we saw in our example.
Additionally, you’re stuck with a higher interest rate for the life of the loan, which means more interest must be paid.
Using the $100,000 loan amount example, you’re looking at an additional $5,148 in interest paid over the full 30 years.
If you hold your mortgage to term, you will pay more with the LPMI option, even with the tax deduction factored in.
Don’t just assume one is better than the other without actually doing the math and laying out a plan.