For the most part (there are a few exceptions such as FHA and VA loans), PMI is added to mortgage payments when the buyer doesn’t have the traditional 20 percent down payment required by Fannie Mae guidelines. PMI payments are included in mortgage payment until the buyer reaches 20 percent equity (or ownership) of the value of the home.
Until recently, the main way to avoid PMI was to “piggyback” a second mortgage, such as a home equity loan or home equity line of credit, to cover the difference between your down payment and the 20 percent required down payment. For example, if you purchase a home for $100,000 and have a $5,000 down payment, you would have to get a home equity loan for the $15,000 difference to avoid PMI. If interest rates are very low, as they were a few years ago, this makes perfect sense. When interest rates rise, it may not. And, with second mortgages, consumers must pay some closing costs, which also make them less financially attractive.
In today’s market, a more financially rewarding and appealing option to avoid PMI is to opt for lender-paid mortgage insurance (LPMI).
LPMI is a relatively new approach to avoiding a monthly PMI payment. To keep it simple and explainable, LPMI is prepaid PMI by your mortgage lender. In other words, your lender pays your entire PMI up-front and rolls the payment into your mortgage rate.
The way it works is that the lender gives the home buyer a slightly higher mortgage rate for their home loan with LPMI. The difference in the amount of the rate depends on several variables including credit score, down payment amount, and total loan value. In most cases the difference in rate is a modest .4 – .6 of 1 percent.
By choosing LPMI, you can avoid the hassles of an extra payment each month for PMI and can usually deduct the interest from your taxes (usually means you should check with your tax advisor to be certain before filing a tax deduction). In addition to simplifying the process for homeowners by rolling PMI into the interest rate, LPMI also gives a lower monthly payment for the period in which the buyer would normally be paying PMI.
In a typical $200,000 mortgage scenario with a credit score greater than 700 and a down payment of less than 5 percent, a person can save around $75 a month on the difference between a mortgage with PMI (at 7.25%) and a mortgage with LPMI (at 7.875%). Despite the higher interest rate, the payment is actually lower, saving the buyer around $900 a year that they can put into some other investment or use to pay off high-interest debt.
LPMI is a very smart alternative to paying PMI or private mortgage insurance; especially for people who don’t plan on staying in their home for more than 10 years (the average American moves every seven years). Consumers are finding that payment relief, no extra PMI payment and reduced closing costs make LPMI a wise choice for fiscally responsible consumers.
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