Do you want to buy a home with a small down payment (less than 20%), but don’t want to pay mortgage insurance? You’re in luck; you can combine a conventional loan with something called lender-paid mortgage insurance (LPMI). With LPMI, you won’t have to pay a monthly private mortgage insurance (PMI) premium.
In the last few years, more and more low down payment conventional loan programs (like Conventional 97 and HomeReady) have popped up on the lending scene. That’s good news for borrowers: there are more conventional mortgage programs today that don’t involve coughing up a large down payment. In fact, the two programs above only require 3% down. But if you chose a small down payment, you’ll need mortgage insurance.
Mortgage insurance exists to protect lenders against losses in the case of a foreclosure; they’ll get their money back should a borrower default. Just like government-insured FHA and VA loans, conventional loans must have mortgage insurance when the loan-to-value (LTV) is greater than 80 (borrowers put down less than 20 percent). Mortgage insurance premiums are paid by the borrower; they’re added-on to the monthly mortgage payment.
Some folks don’t like the idea of paying an additional fee for mortgage insurance. If it’s preventing you from buying a home, your lender can pay the insurance it for you. Lender-paid mortgage insurance works just like it sounds; the lender pays your mortgage insurance premium. In this case, the lender pays it upfront, in a lump sum when the loan closes.
With LMPI, mortgage insurance doesn’t just disappear. There’s no such thing as a free lunch. In exchange for paying your mortgage insurance, lenders charge a higher interest rate (roughly 0.25% to 1.0% higher). So you’re still paying for mortgage insurance, just by a different means.
There are a few differences between borrower-paid and lender-paid mortgage insurance programs you’ll want to know. The following will help you sort out which option is best for you.
Borrower-Paid Mortgage Insurance (BPMI)
Borrower-paid mortgage insurance – as is sounds – is paid by you, the borrower. BPMI is how most borrowers handle mortgage insurance when it is required to get a loan.
In the case of conventional loans, Private Mortgage Insurance (PMI) is used. PMI is an annual premium, divided into monthly installments, that get tacked onto your monthly mortgage payment. The premiums are sent to a third-party mortgage insurance provider, a private company that manages the insurance pool. If a borrower (you) defaults, the private insurer makes the lender whole again. As the principal of the mortgage goes down and the value of the home goes up, less insurance is needed. Monthly PMI payments gradually decrease and eventually go away when the loan-to-value (LTV) ratio reaches 78%.
Lender-Paid Mortgage Insurance (LPMI)
Lender-paid mortgage insurance means your lender pays your mortgage insurance premium in a lump sum (upfront) when your loan closes. In this scenario, you will not have to carry mortgage insurance nor pay monthly premiums. To cover the upfront fee, lenders charge a higher interest rate, 0.25% to 1.0% higher. The interest rate continues, unchanged, for the life of the mortgage.
LPMI is typically only available for borrowers with good credit, a FICO score around 680 or higher.
Lender-Paid Mortgage Insurance Advantages
- LPMI helps people buy a home with as little as three percent down.
- Monthly mortgage payments will be lower.
- Borrowers may qualify for a larger loan amount (thus bigger home).
- Interest rate is slightly higher, however, mortgage interest is deductible and private mortgage insurance is not.
Lender-Paid Mortgage Disadvantages
- Slightly higher interest rate.
- The interest rate is set for the life of the loan (until the mortgage is paid off or refinanced).
- You may pay more over the life of the loan than borrower-paid PMI. Therefore, LPMI is considered financially advantageous if you plan to keep the home for only a few years.
Lender-Paid Mortgage Insurance Example
As mentioned above, the longer you hold the loan, the less advantageous LPMI becomes. You can see how a borrower saves money in the short run but pays more over the long haul in the example below.
Let’s compare BPMI and LPMI on a 30-year fixed rate mortgage, for a home valued at $400,000. The borrower has a FICO credit score of 700 and can make a 3% down payment, or $12,000.
|Borrower Paid MI||Lender Paid MI|
|Total Monthly Payment||$2,384||$2,203|
|Base Loan Amount||$388,000||$388,000|
|Gross Loan Amount||$388,000||$388,000|
|Monthly MI Premium Rate||0.93%||–|
|Monthly MI Payment||$301||–|
|Monthly P&I Payment||$2,083||$2,203|
The lender-paid mortgage insurance scenario above saves the borrower $181 per month. It can also help the borrower qualify for a larger home since less of his/her monthly income will be devoted to a mortgage payment. That’s because the borrower’s debt-to-income ratio changed. Let’s keep the ball rolling and compare total costs over the life of the loan.
|Borrower Paid MI||Lender Paid MI|
|Total Cost (30 years)||$398,175||$405,088|
|Total Interest (30 years)||$361,832||$405,088|
|Total MI (30 years)||$36,343||–|
As you can see in the table above, LPMI costs the borrower $6,913 more over a 30-year period. Generally speaking, the LPMI option saves money if you plan to stay in a home 7 to 10 years but costs more if the mortgage goes to term. Your situation will be unique, therefore your loan advisor should run the numbers and see how BPMI and LPMI scenarios play out.
Lender-Paid Mortgage Insurance Alternatives
Lender-paid mortgage insurance is an option only for conventional mortgages. There are government-insured and PMI alternatives worth considering.
Conventional Loan – Private Mortgage Insurance (PMI) Option
- No upfront mortgage insurance premium like FHA, VA and USDA loans.
- Requires a higher FICO score than government-insured mortgage programs (680 for conventional and around 620 for government-backed loans).
- As little as 3% down payment on Conventional 97 and HomeReady programs.
- PMI automatically terminates a 78% LTV and borrowers can request to remove it at 80% LTV.
FHA Loan Mortgage Insurance
- FHA loans can be made for a little as 3.5% down.
- FHA loans are easier to get as they only require a 620 FICO score (down to 580 in some cases) versus a 680 FICO score requirement for a conventional loan.
- FHA loans require an Upfront Mortgage Insurance Premium (UFMIP) and an ongoing, annual Mortgage Insurance Premium (MIP). The MIP is carried for the life of the loan. You’ll only get out of it when the mortgage is paid in-full or you refinance.
VA Loan Guarantee
- VA loans are zero down.
- You must be an honorably discharged veteran, eligible spouse or active servicemember to qualify.
- VA loans have a one-time, upfront fee called a VA Funding Fee.
- No ongoing monthly mortgage insurance premium.
- USDA loans are zero down.
- They are for low to moderate-income borrowers (there are borrower income limits).
- Properties must be located in an eligible rural area.
- USDA loans have both an upfront funding fee and an ongoing annual mortgage insurance premium.
Another way to avoid mortgage insurance is to finance a first and second mortgage on a home simultaneously.
- The first mortgage covers 80% of the home’s value, thus avoiding the 80% LTV rule that triggers borrower or lender-paid mortgage insurance.
- The second mortgage cover the rest (the remaining 20% of the home’s value). Because the second mortgage is riskier to the lender, the interest rate is higher.
The way to make this work to your advantage is to set up an accelerated payment schedule to knock out the second mortgage faster (say in 5 years).