Lender’s mortgage insurance (LMI), also known as private mortgage insurance (PMI), often comes into play when the down payment on a home is less than 20 percent. Mortgage lenders usually consider this type of mortgage high-risk, and they require the borrowers to pay for LMI until their loan-to-value ratio (LTV) is lower. In late 2014, one in four people who took out a mortgage wound up with LMI tacked on, and most of these borrowers put down only 3 to 15 percent on their new homes.
Although lender’s mortgage insurance lets buyers purchase a home with a smaller down payment, it does come at a cost. Learn more about the reasons why you might want to avoid LMI so that you go into the mortgage-shopping process armed with the information you need.
How Much Does LMI Cost?
LMI can be expensive, costing anywhere from .5 to 1 percent or more of your original mortgage principal annually. If you take out a $250,000 mortgage and your PMI rate is 1 percent, for example, your monthly mortgage payment will increase by $208. Assuming you put down $25,000 on a $275,000 home giving you an 89 percent LTV and your LMI was at 1 percent, you would wind up paying LMI for more than 6.5 years, and your total LMI expense would be more than $15,000.
You may be able to work your LMI expense differently, depending on the lender. Some financial institutions let borrowers pay it upfront so that they have a lower interest rate on their mortgage, but this isn’t always a wise choice. If your home appreciates in value quickly bringing you up to an 80 percent LTV sooner than expected, you do not get a refund on any of the money. When you pay monthly, the premiums stop when you’ve reached the required LTV.
Some lenders let borrowers roll their LMI into their interest rate. That may require you to pay a higher interest rate, but your mortgage interest is tax deductible.
Is It Easy to Cancel LMIÂ When I Reach the Required Equity?
While lenders require you to reach a 20 percent equity stake in the home before they will consider dropping lender’s mortgage insurance, it doesn’t always happen automatically. The Homeowners Protection Act does not require lenders to take any steps to terminate LMI until you have 22 percent equity in the property, and they use the appraised value of the home at the closing to determine the LTV.
If you’ve paid extra toward the mortgage principal, made extensive renovations that have increased the price of your home or live in an area where property values have recently risen, you may be able to petition for early cancelation of your LMI. The lender will require you to submit the request in writing, and they usually also require a new home appraisal to determine the home’s current value.
There are other provisions you will have to meet as well. Your mortgage loan must be current, and the history must not show any payments made more than 30 days late in the last year and no payments made 60 days late in the last two years.
If your mortgage is insured by Fannie Mae or Freddie Mac, you might also face additional provisions. The mortgage loan must be at least two years old. For mortgages that have been seasoned between two and five years, your LTV must reach at least 75 percent before the lender will consider cancelation. If your mortgage is more than five years old, you’ll need an LTV of 80 percent.
It’s important to note that while Federal Housing Administration (FHA) loans come with many benefits, if you have to carry LMI with your FHA mortgage, you will not be able to cancel it at any time. The only way to terminate LMI with an FHA mortgage is by refinancing the loan.
Are LMI Payments Tax Deductible?
Your lender’s mortgage insurance payments may be tax deductible, but it depends on how much you earn each year. If you’re a married couple with an annual adjusted gross income of $100,000 to $109,000 (half of that if filing separately), you may be able to deduct some or all of your LMI. If it’s more than $109,000, it is not deductible at all.
Does Lender’s Mortgage Insurance Benefit Me Personally?
The only benefit lender’s mortgage insurance affords you is that it allows you to take out a mortgage even though you have a relatively small down payment for the home you’re purchasing. Should you pass away before the mortgage is completely paid, your heirs are out of luck. Also, if you have a change in your financial situation and are unable to make your mortgage payments, your lender can still foreclose on your home even though you are paying LMI premiums.
If you’re taking out a conventional mortgage to purchase a home with a down payment that’s less than 20 percent, you’ll be faced with the prospect of paying lender’s mortgage insurance premiums. LMI has one clear benefit: you may be able to buy a home with a down payment of as little as three to five percent. The question you need to figure out is whether it’s worth it to you in the long run to have the extra expense versus waiting until you have more money put away in the bank for a down payment. If you do choose to go the LMI route, make sure that you keep on top of the numbers and work with your lender to drop the PMI at the earliest possible date.
