If you put less than 20% down on your home purchase, you must pay Private Mortgage Insurance if you have conventional financing. Luckily, lenders give you a few options on how you pay it. One of those options is lender-paid PMI.
While the name sounds intriguing – who wouldn’t want their lender to pay their PMI; it’s not what it sounds like. Keep reading to find out what it is and your options to cancel it.
Paying a Lump Sum for Lender-Paid PMI
You have the option to pay your PMI upfront with LPMI. This isn’t the same as borrower-paid PMI that you pay upfront. In this case, the lender determines their overall cost for the insurance and asks for that lump sum from you. The hope is that you pay less than you would with borrower-paid PMI. The lender determines when they think the coverage can end based on how much you will pay and the historical appreciation of the homes in the area.
What this does is prepay for your insurance. You won’t increase your monthly payments because you paid for the premium upfront. The lender now has coverage for as long as they determined should you default on the loan.
Paying Over Time
If you don’t want to give a lump sum of money upfront, you can opt to have a higher interest rate. The lender then covers your payments with the ‘extra’ money they receive on your payments. The paying over time option actually increases the total cost of your loan, though. Unless you refinance, you will have the higher interest rate long after you would have been able to cancel the PMI.
This is only a good option if you can secure a rather low interest rate compared to what the PMI would cost. If your ‘extra’ interest costs are much less than what the PMI would cost, it may make sense. But this is only the case if you know you’ll either sell the home in the near future or you’ll refinance the loan. If you keep the higher interest rate for the life of the loan, you’ll pay excessive interest charges for the loan.
Canceling Lender-Paid PMI
The problem with lender-paid PMI is that you can’t cancel it. If you paid up front, you aren’t going to get a refund. If you opted for the higher interest rate – that’s your rate for the life of the loan.
Before you opt for upfront LPMI, consider your future plans:
- Will you move anytime soon? If you don’t see yourself in the home for at least as long as the insurance covers your loan, then don’t take it. You would be better off with borrower-paid PMI and selling the home when you are ready. You’ll obviously stop paying the PMI when you sell the home. You can calculate the amount of PMI you’ll pay for the time you think that you’ll be there to compare it to the lump sum of lender-paid PMI.
- Will you keep the loan? Even if you think you’ll stay in the home, will you keep the loan? Many people like to refinance as soon as interest rates fall. If you are that type of person, don’t pay the PMI upfront. You may stand a better chance of refinancing and eliminating PMI because you either paid the balance down faster or your home appreciated. Sometimes it’s even a combination of both.
If you opt for the higher interest rate, you can’t change your rate mid-mortgage. You are stuck with it until you sell the home or refinance the mortgage. Before you opt for this option, you must consider your plans.
- Will you move soon? If you will move soon, this option could be the better choice, assuming the increase in interest is less than the PMI would cost monthly. Once you move and pay off the loan, you no longer owe the higher interest rate. If your savings will be greater with the higher interest rate, go for it. You’ll have the added benefit of being able to write the extra interest off on your taxes.
- Will you refinance? If you know you will refinance in the near future, take the higher interest rate. When you refinance, you can lower the interest rate (hopefully) and even get rid of the need for PMI. If you can make extra payments towards your principal, you increase your chances of eliminating the PMI altogether.
While you can’t cancel lender-paid PMI officially, there are ways around it. Before you choose an option, think about what you want to do with the home. If you aren’t sure, sometimes taking the borrower-paid PMI is the better option as it gives you more choices for cancelation moving forward.