Buyers tend to hear the words “mortgage insurance” and jump straight to negative thoughts. They don’t want to pay it and will try to avoid it at all costs. The truth is that mortgage insurance is one of the few ways you can purchase a property with less than 20% down.

What is Mortgage Insurance?

Private Mortgage insurance is insurance that covers a Lender “Bank” in case a borrower defaults on their loan. When someone buys a home and takes out a mortgage (loan), the lender needs to ensure that they have a plan B in case you default (don’t pay). If you put 20% down, you already have that money tied up in the property. If you don’t pay your mortgage the bank can take back your property as well as keep the 20% you put down.

When buyers put less than 20% down the bank or lender is taking a risk. If you don’t pay your mortgage and the bank takes back the property there may be costs for them to fix the property due to deferred maintenance, hire a realtor to market and sell the property, or the take the property to auction. With all risks there is an insurance help offset it and in this case that is mortgage insurance. The lender passes this cost on to the borrower and it is something that must be accounted for in your total monthly payment. Mortgage insurance is calculated based on several factors including % of down payment and credit score. The more down payment you have, the less the insurance will cost.

Monthly Mortgage Insurance

There are two main options when it comes to mortgage insurance. The monthly option is an extra monthly payment specifically for insurance that is paid on top of your mortgage. This payment will depend on your loan amount as well as the amount of down payment. Typically this option leads to a higher monthly payment in the first few years as compared to the lender paid option. The good thing about this option is once your loan amount gets to 78% of the value of your home (LTV) then the monthly mortgage insurance payment goes away. This means that your payment now becomes less expensive than the lender paid option.

This option is good if you have closer to 20% down payment or if you plan on keeping the property long term.

Lender Paid Mortgage Insurance (LMPI)

Lender Paid Mortgage Insurance or “LPMI” is a second type of mortgage insurance that some lenders may offer. The cost of the insurance is usually rolled into an adjustment in your interest rate. Depending on the amount of down payment this adjustment will be higher or lower (+.125% to +.625%). There is no extra monthly payment but this adjustment will cause your mortgage payment to increase. Typically this option leads to a lower monthly payment than the monthly mortgage insurance option at the beginning of your loan but the interest rate does not change. This means that at the point when your loan amount reaches 78% of the value of your property, the LPMI option becomes more expensive than the monthly option.

This option may be beneficial if you have a lower down payment (5%-10%) and you want to save money in the beginning. It may also be beneficial if you are not sure how long you will keep the property and may not see a benefit from the monthly mortgage insurance going away when your loan amount reaches 78% of the value.

There may be tax consequences associated with both options but please consult a loan officer or your CPA.

Which option is better?

When looking at loan options, I always advise clients to look at the purpose of the property and figure out how long they plan to live there or hold on to the property. If the property is just a starter home that they plan to keep for 2-3 years then the LPMI option might be best since they will have a lower monthly payment for the first few years. If the plan is to hold on to the property forever then the monthly mortgage insurance option might be a better to take advantage of the lower interest rates.

If you are interested in getting pre-qualified with a lender Contact Me today for a list of my preferred loan officers