Learn About Lender Paid Mortgage Insurance (LPMI)
Mortgage insurance is required whenever your down payment is less than 20% of your home’s value. This insurance protects your lender in case you fail to pay the mortgage. While it’s unfortunate to have to pay mortgage insurance, the upside is that you can buy a home without plunking down 20% (which might take a few more years’ worth of saving). Whether or not it’s a good idea to buy with less than 20% down is debatable, and is a topic for another article.
Typically, you (the borrower) pay a monthly premium for private mortgage insurance (PMI). It’s an extra cost each month, and it can take a little bite out of your budget. However, some lenders offer lender paid mortgage insurance (LPMI), which allows you to avoid that extra monthly payment.
Unfortunately, LPMI is not a very good name because the lender doesn’t really pay for the insurance – you do. Always remember (especially with financial transactions) that nobody is going to pay any costs for you unless they get something in return.
How LPMI Works
To use LPMI, you simply change the structure of insurance premium payments so that you don’t pay a separate charge every month. Instead, you either pay a lump sum up front, or you make larger mortgage payments every month. The lump sum approach is less common than an adjustment to your mortgage rate.
If you pay in a lump sum, your lender will determine an amount that they think will cover their costs (because they’re going to buy mortgage insurance with that money) given the details of your home purchase.
If, on the other hand, you pay over time, you’ll pay in the form of a slightly higher mortgage rate. Because a higher mortgage rate means higher monthly payments (see How to Calculate Loans) you’ll end up paying a little more each month if you go for LPMI, but it might be less than you’d pay if you got PMI separately.
Things to Consider
LPMI is not for everybody. In fact, not everybody will qualify for a loan with LPMI. Generally you’ll have to have good credit for LPMI to be an option, and it's only attractive in certain circumstances.
High income earners: for those who can use LPMI, it is most attractive for borrowers with high incomes; they may enjoy a greater tax deduction because of the higher interest rate (assuming they deduct home mortgage interest costs). People with lower incomes, on the other hand, might be able to deduct stand-alone PMI, so LPMI would not bring any additional tax benefits. Of course, you should always talk with your tax preparer about potential deductions – and even how best to structure your mortgage loan. These rules have been changing lately, so check with an expert before you do anything.
Short-term loans: LPMI is most attractive with shorter term loans (it’s not for the borrower who gets a 30 loan and makes payments for many years). Why? Again, most LPMI loans involve an increased mortgage interest rate, as opposed to a lump-sum up front, which can haunt you for years. That mortgage rate will never change, so you’ll have to pay off the mortgage completely to get rid of the LPMI “premium.” You can do this either by paying the loan off out of your own savings (easier said than done) or by refinancing.
Contrast this with PMI, which you can cancel once you build sufficient equity in your home – then you get to enjoy a lower interest rate (and no more PMI payments) for the remainder of your loan’s life.
High LTV: if your loan to value ratio (LTV) is close to 80%, LPMI is probably not your best option unless you plan to get rid of the loan soon (by refinancing or prepaying). Near 80%, you're almost done with mortgage insurance altogether. If you use PMI instead and make a separate payment each month, you’ll be able to cancel the insurance relatively soon, and you won’t be stuck with a higher interest rate. Remember that you might get above 80% LTV by making payments, or it could happen if your home’s value increases due to a strong housing market. Getting your PMI cancelled may only involve costs of a few hundred dollars (to get an appraisal), while it will cost much more to refinance.
Alternatives to LPMI
If you don’t like how LPMI sounds, there are a few alternatives. First, you can make a larger down payment of at least 20%. However, many people don’t have that option. Another choice is to pay for your own PMI (sometimes called borrower paid mortgage insurance or BPMI). You’ve already seen a few examples of situations where plain-old PMI is better than LPMI above. Finally, you can use a piggyback loan (or 80/20 loan), although these loans are not as common as they used to be. A piggyback allows you to avoid mortgage insurance altogether, but your second mortgage will come with a higher interest rate. If you can pay off the second mortgage reasonably quickly, you’ll eventually enjoy having a low (not increased by LPMI) mortgage rate for years to come.