When you’re buying a home and your down payment is less than 20% of the purchase price, your lender will likely require you to pay private mortgage insurance (PMI) premiums each month.
The rates for PMI can vary, but typically range between 0.3% and 1.2% of the loan amount on an annual basis.
Why is this? Well, because the downpayment consists of less than 20% of the purchase price, the bank needs to protect their investment (and minimize the detrimental impact) in the event that you were to stop making payments and had to go into foreclosure.
Luckily, for some homebuyers, lender-paid mortgage insurance (LPMI) may be a solid option to avoid paying PMI on a monthly basis while simultaneously lowering their overall monthly payment.
How does LPMI work?
At its core, LPMI is a type of mortgage insurance that your lender re-structures in a way that’s different from standard PMI. Typically, LPMI coverage is organized in one of two ways:
- The borrower pays a one-time “lump-sum” payment at the beginning of the loan.
- The lender places a higher interest rate on the loan which lasts for the life of the loan.
Typically, borrowers usually opt for paying a higher interest rate over the life of the loan.
Can I Really Lower My Monthly Payment?
If you’re going to be paying PMI each month, then it might be worthwhile for you to look into LPMI– you may even be able to lower your monthly payment.
Let’s dive into a hypothetical example between two different loan scenarios and determine the long-term impact of each one:
- Purchase Price = $400,000
- Downpayment = $40,000 (10%)
- Loan Amount = $360,000
- Interest Rate with LPMI = 5.375%
- Interest Rate without LPMI = 5%
- Mortgage Term = 30 years
So, now we’ll run a decision calculator to see what’s actually happening underneath the hood:
Looking at the example above, when opting for LPMI, you’ll likely to have to pay a higher interest rate. But, by choosing the LPMI option, you’d actually end up saving about $31/month.
It’s important to recognize that these monthly savings are only for a time. With the traditional PMI loan, you’d be eligible to cancel your PMI in 91 months or 7.5 years. Once you cancelled your monthly PMI, you’d be saving $114/month (much more than $31/month that you were saving with the LPMI option).
So, what are the long term implications in this scenario? Basically, with LPMI, you’d be saving about $31/month, but those savings only last for about 7.5 years. However, if you had chosen the traditional PMI loan, your monthly payment would be higher, but you would actually end up saving $19,628 over the life of the loan.
When is LPMI Good For Me?
Everyone’s personal financial situation is different. However, there are some basic principles that we can derive from the scenario above. LPMI may be right for you if:
- You plan on staying in the home for the short term (in the example above, 7.5 years or less).
- You plan on re-financing in the near future
If you’re planning on staying in the house long term, LPMI may not the best option because you’ll end up paying more over the life of the loan. But, if you know that you’ll only be in the house for a short time, you might be able to save more money each month using LPMI.
Additionally, if for some reason, you know that you’ll be refinancing in the near future, LPMI may also be a good option to keep your monthly payments lower for that short period of time. But, it’s also important to realize that most lenders are forecasting that rates are expected to rise in the near future. So, if you are planning to refinance, you run the risk of ending up with a higher interest rate which would definitely impact the long term cost of your loan.
Mastermind With Your Lender
Regardless of your situation, I would definitely recommend that you consult with your lender as to what’s the best for you. Make sure you take the time to share your short-term and long-term goals, wealth-building goals, and what you hope to accomplish with the purchase of your home. A lot of times, it’s easy to assume that your lender will automatically know what’s best for you. But, unless you take the time to collaborate with them, they actually won’t know what’s best for you.