Lender-paid Mortgage Insurance (PMI) and How it Works
Most mortgage programs require borrowers to buy mortgage insurance coverage when they borrow against more than 80 percent of a home's purchase price or value. It can be expensive (the cost is added to the borrower's monthly payment), and may not be tax-deductible for borrowers earning over $100,000 per year. There is another option, though. You could have your lender pay the premiums.
Lender-paid PMI: Who Really Pays?
Having lender-paid PMI (LPMI) means you don't have an extra premium added to your mortgage payment, but the payment itself will be higher. With LPMI, the mortgage lender pays the mortgage insurance premium upfront and then passes on the cost to the borrower in the form of a higher interest rate – typically .25 to .5 percent higher.
So what's the point of getting it? You might be better off paying tax-deductible mortgage interest instead of mortgage insurance premiums. It depends on your income and tax preparation.
If you earn too much to deduct mortgage insurance, and you file a Schedule A. lender-paid insurance might be a smart choice.
- If you don't itemize your deductions on a Schedule A, deductibility is not a factor.
- If you can deduct all of your mortgage insurance, it doesn't matter, tax-wise, which option you select. You can deduct the expense either way.
- If deductibility is not a factor, you'd only choose lender-paid PMI if it saves you money. In other words, which option costs the most over time and / or requires the largest payment?
Federal disclosure laws require mortgage lenders to disclose the following information to borrowers:
- LPMI cannot be canceled by mortgage borrowers unless the mortgage is refinanced or paid in full. Private mortgage insurance may be canceled when the mortgage balance falls to 80 percent or less of your home's current value and applicable mortgage lender requirements are met.
- Lender-paid private mortgage insurance typically results in a higher mortgage rate than if you pay for mortgage insurance.
- Both lender and borrower paid mortgage insurance have benefits and drawbacks. Mortgage lenders are required to provide a generic analysis of both options that assume
prevailing mortgage rates and property appreciation rates.
- If you select a mortgage with lender-paid mortgage insurance, your mortgage servicer must notify you within 30 days of the termination date for borrower paid mortgage insurance of options for refinancing or otherwise terminating your mortgage with lender-paid private mortgage insurance.
These rules are designed to protect mortgage borrowers and help them choose the right option for their circumstances.
Factors Related to Lender or Borrower Paid PMI Vary
When deciding how you'd like your mortgage insurance paid, consider these factors:
- Compare the monthly payment of a loan with a higher rate to the same loan with mortgage insurance premiums.
- Private mortgage insurance premiums are based on the borrower's credit rating, the type of property, loan-to-value and type of loan. If your profile requires very expensive private insurance, you might be better off with LPMI.
- Borrower-paid mortgage insurance premiums go away once the borrower has paid the mortgage down to 80 percent of the purchase price or property value when the loan was funded. Lender-paid insurance does not. Lender-paid premiums don't offer that option; you'll pay the higher rate until you refinance or sell your property.
Running the Numbers
There are a number of factors that affect your costs and your decision. They include:
- Your credit score
- Loan-to-value ratio
- LPMI mortgage rate
- Mortgage rate without LPMI
- Loan Purpose
- Years expected to have the loan
- Expected home appreciation (Four percent is national average)
It can get pretty complicated, but there is a nice little calculator created by mortgage insurer Radian. The picture below shows the results for a borrower planning to keep the property for just five years, versus a borrower who plans to keep the property for ten years, assuming a property appreciation rate of four percent per year. In the shorter term, the LPMI is $1,076 cheaper. But in the long run, the borrower-paid MI saves the borrower 3,391, because eventually the PMI payment goes away.
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