If you are stretching your funds to purchase a home with a minimal down payment, you are probably familiar with private mortgage insurance (PMI). It is generally required in any home purchase in which the down payment is less than 20%. PMI is insurance for the lender, not for you — it covers the lender for the increased default risk that you present.
Typically, lenders arrange PMI through a third-party insurer. The premium is calculated based on a percentage of your loan amount and incorporated into your monthly payment. The PMI lasts until you no longer pose a heightened risk of default, usually near the 20-22% equity range.
If you have a hard time accepting this approach, consider a variation of PMI offered through lenders. In this lender-based alternative, known as LPMI, the lender pays the PMI and passes that cost on to you through a higher interest rate on your loan and/or an upfront fee. LPMI often results in a lower initial monthly payment, which could make the difference in being able to afford your dream home.
The main disadvantage of LPMI is that it cannot be cancelled. In essence, LPMI spreads out your mortgage insurance over the life of the loan. Typically, you are trading a lower initial monthly payment front-loaded with PMI for a higher monthly payment in later years. Depending on the interest rate, you may be paying a lot more over the long run — which is why most borrowers who expect to stay in their home for a considerable time opt for traditional borrower-paid PMI.
LPMI does provide a tax advantage. Since LPMI is tied into the interest rate of your loan, it is also tax deductible because it is considered to be part of your tax-deductible mortgage payment. Traditional PMI is considered separate and not deductible as of this writing.
The keys are the combination of interest rate, the size of the loan, and the time you expect to stay in the home. If the interest rate is low enough or you can lower the rate with some upfront fees, it may not matter that the LPMI lasts for the life of the loan. LPMI also makes more sense if you do not intend to stay in the home for a long enough time to reach the 20% equity point that would allow you to cancel traditional borrower-paid PMI. To find out if LPMI is a better option for you, work with your loan officer to do a direct comparison of your costs, both monthly and over the life of the loan.
Regardless of the style of mortgage insurance that you choose, there are two ways to keep your premium as low as possible. Casey Fleming, Author of The Loan Guide and Mortgage Advisor at C2 Financial Corporation, explains: "Mortgage premiums today are very highly credit score driven, so the higher your credit score, the lower your premium will be with all other things being equal...[they are] also very dependent on your loan-to-value ratio and it's done in steps." Essentially, the higher your credit score and the lower your loan-to-value ratio is (i.e. more down payment), the lower your premiums will be. You can check your credit score and read your credit report for free within minutes using Credit Manager by MoneyTips.
Of course, if you can afford to make a 20% down payment or more, PMI is not an issue. You may want to consider waiting until you can place 20% down to make your purchase, but in that case you risk missing today's relatively low interest rates — unless you can compensate with future improvements in your credit score.
If you decide not to wait, work with your chosen lenders, and remember to consider PMI options as you shop around. Armed with a cost-benefit analysis, you will be able to make the best mortgage insurance choice to fit your needs.
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