If you put less than 20 percent down on the purchase of a home, you are going to have to pay Private Mortgage Insurance, but it is not as simple as you might think. You have options when it comes down to how you pay the insurance. There is no getting around having it in one form or another, but you do have options on how you pay for it. The most common way is to pay on a monthly basis, but you can also have the lender pay it up front for you, eliminating those monthly charges.
The Difference Between Monthly and Lender Paid PMI
If you choose to pay the PMI yourself on a monthly basis, you are given a PMI rate and it is charged to you with your mortgage payment, on top of your principal and interest. You pay this amount for the period of time that your loan-to-value ratio remains above 80 percent. Once you hit below 80 percent you can have the insurance cancelled. If you opt for lender paid mortgage insurance, the lender “pays” the insurance up front for you; however, you pay in other ways. The most common way is with a higher interest rate for the life of the loan. This way the lender still makes the same profit and you are not paying the insurance fees every month. In the end, the amount you pay comes out around the same in the beginning, but is higher in the long run, when you hit below 80 percent LTV because the insurance could have been cancelled and you are still paying the same high interest rate well beyond the time you hit an 80 percent LTV.
Reasons to Avoid Lender Paid Mortgage Insurance
- It seems obvious – why would you pay a higher interest rate for the life of the loan when you could lower your payment after the first 7-10 years when the insurance would be able to be canceled? There are other not so obvious reasons why lender paid mortgage insurance is not always the right choice:
- Low loan-to-value ratio – If you pay the full premium for mortgage insurance by having the lender pay it up front, yet you only borrowed 85 percent of the purchase price of the home, you are overpaying for the home. The mortgage insurance that was paid was for the life of the loan, not just for the period of time it will take you to pay down that 5 percent to get you to an 80 percent loan-to-value ratio. If this is the case, you are paying too much for mortgage insurance and are stuck with the higher interest rate too. In essence, you are being penalized twice. It would make more sense to take the monthly PMI and have it cancelled once you hit an 80 percent loan-to-value ratio.
- You are staying in the home a short time – Again, because the lender paid mortgage insurance is essentially paying the full amount of the private mortgage insurance, you will end up losing if you are only staying in the home a short while. Monthly PMI, while an added cost, is only for the time period that you own the loan. If you are only staying in the home for a few years, it is usually less expensive to pay it on a monthly basis. If you are considering having the lender pay the mortgage insurance, ask what the cost would be for the insurance compared to the monthly PMI you would pay over the length of time you see yourself staying in the home. For example, if you are staying in the home for 3 years (36 months), calculate the amount of money you would pay per month x 36 months and compare it to the amount the lender will pay upfront for you. In addition, compare the PMI total for 3 years to the difference in the higher interest payment you will pay in exchange for the lender paid insurance. This will help you decide which is the right decision for you.
- You have low to medium-sized income – If you are not a “high income earner” as is determined by the IRS, you can deduct the monthly PMI rates you pay on a monthly basis yet again this year. The extension was granted for 2015 for those people that fall within the income limits. If you are a low to medium-sized income earner, this could be more beneficial to you than writing off slightly higher interest charges.
- Refinancing is not an option – If you are going to be able to refinance your loan in the near future, it could be worth it to take the lender paid mortgage insurance and deal with the higher interest rate for a short period of time. But, if there is any reason you would be unable to refinance, such as you are moving into a neighborhood that has not appreciated much in recent years; you know your debt-to-income ratio is going to increase in the near future making it hard to get a new loan; or you have some type of credit issue that comes up, you are stuck with the higher interest rate provided to you with the original loan. If the interest charges are significant enough, they could cost you more than the insurance payments would have cost and have been able to be removed once you hit that 80 percent threshold.
There are always pros and cons to how you pay your Private Mortgage Insurance. Always find out all options that are available to you and calculate which would be the best decision in the long run. Do not just think about the present and what will get you into the house you want – a mortgage can be yours for up to 30 years, so it pays to think about the future and how much you want to be paying in the years to come. You might find that paying the insurance yourself is the best option after all.
Justin McHood is America's Mortgage Commentator and has been providing expert mortgage analysis for over 10 years.