Did you know that you have options on how you pay your Private Mortgage Insurance when you put less than 20% down on a conventional loan?
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Most people think they have to deal with the addition to their monthly mortgage payment, but there are actually ways around it. You can opt for lender-paid mortgage insurance, but is it right for you?
What is Lender-Paid Mortgage Insurance?
As the name suggests, lender-paid mortgage insurance means that the lender pays your PMI. Rather than paying it in monthly payments, as you would with borrower-paid PMI, the lender pays the entire bill upfront.
Now you probably wonder why the lender would go and foot a large bill like that for you. First, they don’t’ do it out of the kindness of their heart. There is a way that they will make the money back. Typically, it’s through a higher interest rate on your mortgage. This way the lender makes the money back that they paid for you over the life of the loan.
Does Lender-Paid Mortgage Insurance Make Sense?
Now you need to ask yourself if letting the lender pay your mortgage insurance makes sense. If they pay the bill upfront and you just have to deal with a slightly higher interest rate, it sounds good. But there are a few situations where it doesn’t make sense:
- If you know you’ll move in the next few years, you shouldn’t do it. If you opted for monthly PMI, you would only pay PMI for the time that you are in the home. Chances are the total of what you’d pay monthly before moving wouldn’t equal the full amount of the premium that the lender would pay for you. Unless you can get a killer interest rate even with the lender-paid PMI, you’ll probably pay more in interest during the time you are in the home than you would have paid in monthly PMI.
- If you’ll stay in the home for the entire term, it may not make sense. Borrower-paid PMI gets canceled once you owe less than 80% of the home’s value. If your home appreciates fast and/or you pay your principal balance down faster, you may cancel your borrower-paid PMI sooner. With lender-paid PMI, the lender pays the full amount and you are stuck with the higher interest rate for the entire term. If you add up the extra interest you’d pay versus the PMI you would pay if you did borrower-paid PMI, you’d probably come out on the losing end with lender-paid PMI.
- If you make a large down payment, don’t opt for lender-paid insurance. Again, because you can cancel PMI once you owe less than 80% of the home’s value, you probably won’t owe the full amount of PMI if you make a large down payment. Because the lender will pay the full amount, you’ll be stuck paying the higher interest rate for the life of the loan, unless you refinance. That would incur more costs and make the loan more expensive in the end. If you have close to 20% to put down, but not quite 20%, just pay the PMI yourself.
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While you typically have the option to refinance and get out of the higher interest rate, you have a few things to consider:
- It costs money to refinance. Depending on the closing costs, a refinance could cost several thousand dollars. It may not make financial sense to refinance just to get the lower interest rate if you’ll pay the same amount in the end.
- You have to be able to qualify to refinance. If you know that you may change jobs or your debt ratio may increase because you’ll go down to one income in your household, refinancing may not be an option. This means you’re stuck with the highest interest rate for the life of the loan.
- Your property must appreciate. If your property doesn’t appreciate and you pay your loan as scheduled, you may still have a rather high LTV a few years down the road. This could leave you stuck with the same interest rate until things change, which could make it more expensive to take the higher rate.
Lender-paid mortgage insurance isn’t always the right choice. If you know you’ll live in the home for a long time and that you can secure a ‘decent’ interest rate, it may make sense. But you have to do the math. Determine how much the higher interest rate will cost you in extra interest over the life of the loan. Then compare that to the total cost of what borrower-paid mortgage insurance would have cost. Choose the option that has the lower total cost.