Coming up with a 20 percent down payment on a home can be difficult, especially for first-time homebuyers who don't have the equity that existing homeowners may have when selling one home so they can buy a bigger one.
Without that 20 percent down, many lenders will require mortgage insurance if the loan is for more than 80 percent of the home's value. The insurance will be paid to the lender if the borrower defaults on the loan. It's commonly called private mortgage insurance, or PMI, and is an added payment to the monthly mortgage that is removed when the loan is for more than 80 percent of the home's value.
PMI isn't the only way to qualify for a home loan without having a 20 percent down payment. Lender-paid mortgage insurance, or LPMI, allows a mortgage lender to pay the mortgage insurance premium upfront in a lump sum. The cost is passed on to the borrower through a higher interest rate, normally about a one-quarter percentage point higher, says Jeremy David Schachter, branch manager Pinnacle Capital Mortgage in Phoenix, Ariz.
Credit scores, down payment and your debt-to-income ratio all determine the LPMI rate. Because LPMI payment is rolled into your mortgage, the monthly payment is less than it would be with PMI because the LPMI payment is spread over the life of the loan, such as 20 or 30 years.
Here's an example from Matt Perillie, sales manager at Campbell Mortgage Services in North Haven, CT. It assumes a $200,000 loan with a 90 percent loan to value.
A standard PMI loan would be around 4 percent, and the LPMI rate would be 4.375 percent. For a 4 percent loan on a 30-year fixed mortgage with PMI, the principal and interest would be $954.83, plus a monthly PMI of $73.33, for a total payment of $1,028.16.
For the same 30-year fixed mortgage, but with LPMI at 4.375 percent interest, the principal and interest would be $998.57. That's $29.59 less per month than the loan with PMI. But after about eight years, that savings disappears if the PMI is removed.
Length of holding loan important
Since PMI will eventually come off of the loan, and LPMI won't, the PMI loan will be cheaper in the long run. "Usually, with 10 percent down and a regular payment schedule it will be about year eight before the lender paid PMI ends up being a higher cost," Perillie says.
Schacter says he recommends to clients who need private mortgage insurance to get LPMI if they're going to live in the home for seven years or less. They'll get a cheaper loan rate with PMI, but lower payments with LPMI, he says.
"People always think they're going to stay in one house forever," he says of the misconception of 30-year loans. "But that doesn't happen. Life happens."
Most people don't keep their mortgage for more than 10 years, says Michael Regan, a mortgage banker in Petaluma, Calif.
New loan agents don't use LPMI so much because they're more rate driven and want to show a client a low interest rate, Regan says. "But if you really beak it down for the client," you can show them the savings of LPMI, he says.
He estimates that 40 percent of his clients need mortgage insurance, and LPMI helps them be able to afford a home that they're likely to live in for 10 years or less, Regan says.
Other pros, cons
Besides having a lower payment - at least for eight years or so when compared to PMI - LPMI is tax deductible because it's rolled into a mortgage payment, and mortgage interest is tax deductible.
With PMI, lenders automatically drop the mortgage insurance payments after the loan value alls below 78 percent of the original value of the home, though homeowners can ask for it to be dropped at 80 percent.
To reduce the cost of LPMI, borrowers can pay down the interest rate by buying discount points. It could drop the mortgage interest rate to what it would be without the LPMI increase. Another option is to have the lender pay only part of the mortgage insurance upfront, leaving you with PMI that's less than what it would otherwise be.
If you do decide to get LPMI because you can't afford the down payment that your lender wants, remember that it's a payment you'll be making for as long as you own the house. Or at least until you refinance the loan at a lower rate.