How Lender-Paid Mortgage Insurance (LPMI) Works
You Still Pay, But the Process is Different
Most lenders require homebuyers to purchase private mortgage insurance (PMI) whenever their mortgage down payment is less than 20% of the home’s value. In some cases, your lender arranges this coverage at the beginning of your loan, in which case it becomes lender-paid (LPMI).
If given a chance to choose, you may be tempted to take LPMI over standard PMI, but you should know that names can be deceiving.
What Is Private Mortgage Insurance?
Private mortgage insurance is coverage that protects a lender when a borrower doesn't pay their mortgage. When a buyer can put less than a 20% down payment on a mortgage—leaving an 80% loan-to-value (LTV)—they are seen as being more likely to default on the loan.
If you are getting an FHA loan, you will be required to get PMI. Another important factor with FHA loans: Once you are tasked with paying PMI, you can never remove it for the life of the loan—unlike standard financing.
Typically, you (the borrower) pay a monthly premium for private mortgage insurance on top of your payment of the mortgage and escrow. Escrow is accumulated funds in an account that will be used to cover annual property tax and homeowner's insurance needs. PMI is an extra cost each month, and it takes a bite out of your budget. You can see how PMI increases your mortgage payment using a mortgage calculator.
How Lender-Paid PMI Works
LPMI is mortgage insurance that your lender arranges. This arrangement sounds great if you base that decision off of the name only. However—as with all things in life—nothing is free, and that includes LPMI. You will pay for the lender protection coverage in one of two ways:
- A one-time payment at the beginning of your loan (a “lump-sum” payment).
- A higher interest rate on your loan, resulting in higher monthly mortgage payments every month, for the life of your loan.
The lump-sum approach is less common than an adjustment to your mortgage rate.
Unfortunately, the term LPMI is not accurate because the lender doesn’t pay for insurance—you do. Always remember, especially with financial transactions, that nobody pays costs for you unless they get something in return. When using LPMI, you just change the structure of insurance premium payments so that you don’t pay a separate charge every month.
If you pay a lump sum, your lender determines the amount they think will cover their costs. Then, they buy mortgage insurance with that money. In this case, you prepay for coverage.
If you pay over a set period, the lender adjusts your mortgage rate to cover the costs of insurance. Because a higher mortgage rate means higher monthly payments, you’ll end up paying more each month if you go for LPMI. That higher payment should be less than you’d pay if you used a separate PMI charge every month, but there’s no way to “cancel” the extra cost as you pay down your loan.
Pros and Cons of LPMI
LPMI is not for everybody. The reality is not everybody will qualify for a loan with LPMI. Typically you need to have good credit for LPMI to be an option, and it only makes sense in certain situations.
LPMI is most attractive for shorter-term loans. If you plan to get a 30-year loan and make payments for decades, you might be better off with a separate PMI policy. Why? Again, most LPMI loans use an adjusted (higher) mortgage interest rate, as opposed to a lump-sum payment upfront. That mortgage rate will never change, so you’ll have to pay off the loan completely to get rid of the LPMI “premium.”
For comparison, look at a standalone PMI policy, which you can cancel once you build sufficient equity in your home. After canceling, you benefit from a lower interest rate—and no more PMI payments—for the remainder of your loan’s life.
When the extra cost is built into your loan payment, you're stuck with it as long as you keep the loan.
For those who can get approved for LPMI, it is most attractive for borrowers with high incomes. Those individuals and families may enjoy a greater tax deduction because of the higher interest rate, assuming they deduct home mortgage interest costs (not everybody does).
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 change periodically, so check with an expert for updates before you decide on anything (and be prepared for things to change after you make your decision).
High Loan-to-Value Ratio
If your loan-to-value ratio is close to 80%, LPMI is probably not your best option unless you plan to get rid of the loan soon, either by refinancing or prepaying. Near 80%, you're almost free of mortgage insurance altogether. If you choose a separate mortgage insurance policy instead of LPMI, you can make a separate payment each month. Soon, you’ll be able to cancel the insurance, and you won’t be stuck with a higher interest rate.
Getting your PMI canceled early may only involve costs of a few hundred dollars (to get an appraisal). But refinancing out of an LPMI loan can cost much more.
Alternatives to LPMI
If LPMI doesn’t sound like the perfect fit for you, you can try several different approaches.
Bigger Down Payment
By putting down at least 20%, you eliminate the need to pay PMI. However, many buyers don’t have that option.
Buy Your Own PMI
You can always pay for your own PMI (sometimes called borrower-paid mortgage insurance, or BPMI) every month. You’ve already seen a few examples of situations where regular PMI is better than LPMI above.
You can also try a combination of loans to avoid PMI, although you need to review the numbers carefully. A piggyback strategy, also known as an 80/20 loan, is just one option. This strategy is not as common as it used to be, but it may be an option for you. 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 quickly, you’ll eventually have a single loan with a low mortgage rate (which does not include LPMI costs) for years to come.
Several loan programs allow small down payments. For example, FHA loans are available with as little as 3.5% down. You have to pay for mortgage insurance, but those loans might be a better fit for some borrowers. VA loans allow for zero down, and they don’t require any mortgage insurance.