If you’re considering to finance over 80% of the purchase price (or appraised value on a refinance) of a home, you’ll want to know how you can do it.  You may believe the myth that you must carry private mortgage insurance (PMI). The good news is, there are alternatives!   If you need a quick catch up on why you need to have PMI, check out the post on ‘The Why Behind Mortgage Insurance’. 

I used to tell customers that having mortgage insurance was like lighting your money on fire. There was no big benefit in carrying it (now it CAN be tax deductible).  The mortgage insurance company continued to collect a premium from you every month until your loan reached 78% loan to value.  Really the only alternative at the time was to get a 2nd mortgage and unfortunately some clients didn’t qualify for one.

Now in 2008, the 2nd mortgage market stinks due to some pretty tough default rates. It is important to recognize you have choices as a borrower.  I want to talk about Lender Paid Mortgage Insurance (LPMI) .  LPMI is an excellent alternative to Private Mortgage Insurance (PMI).  Lender paid mortgage insurance was born to compete with combo loans (such as an 80/20 or 80/10/10).  Combo loans very quickly cut into the mortgage insurance companies profits because combo loans offered more affordable payments, and more tax deductions for borrowers.  Lenders liked combo loans because they offered a more profitable alternative to PMI because the bank could collect more money in interest and ultimately fund more loans with the product.

In order to take back their market share of borrowers financing over 80%, mortgage insurance companies decided to offer a couple alternatives to their traditional ‘Monthy Private Insurance Premium’.  Lender paid mortgage insurance was created to allow lenders to pay for the policy on behalf of the client and pass the cost onto the customer through the interest rate they pay on the mortgage.

Here is an example: Purchase price of $150,000 and financing 100%.  Both loans are 30 year fixed rate loans.  Rates are simply for illustrative purposes only.

Option 1: 100% Loan with Private Mortgage Insurance (Monthly PMI)

               Interest Rate: 6%
               Principal and Interest Payment: $899.33
               PMI Premium: $121.25
               Total Payment: $1,020.58

Option 2: 100% Loan with Lender Paid Mortgage Insurance (LPMI)

               Interest Rate: 6.625%
               Principal and Interest Payment: $960.47
               PMI Premium: (included in interest payment)
               Total Payment: $960.47

Difference in payment of: $60.11

You’ll quickly see that even though the interest rate you pay is higher, but the payment is significantly less!

To be fair, here is a quick breakdown of the good and the bad of Lender Paid Mortgage Insurance:

Advantages:

• Tax deductible without income restrictions.
• Often a lower payment.
• Keep one monthly mortgage payment (as opposed to an 80/20).
• Less closing costs than having a 2nd mortgage.
• Less cash at close (you must escrow for 2 months of PMI).

Disadvantages:

• Your rate will never decrease (even if your lender doesn’t have to pay PMI anymore).
• LPMI rate adjustments are HIGHLY based on credit score.
• Some lenders do not offer LPMI.
• Higher interest rate (but lets face it, it’s no worse than the alternative!)

These lists are always growing, remember it’s extremely important to know your options!

For the record, every client I work with receives all their options in our consultation.  We decide which strategy will compliment their long term goals with the mortgage they select to go with. 

Here are some key questions to consider when choosing which solution is right for you:

• How long will you own the home?
• Do you plan on you or your spouse’s income to increase?
• How quickly do you think the home will appreciate?
• How much adjusted gross income do you have each year?
• How long do you plan to keep the mortgage?

Selecting the right way to finance a home is a tough decision.  Just make sure you’re working with a professional that explains your options throughly and then advises you which option is most suitable for you and your family!