People who want to buy a home with less than 20% down have plenty of options in 2018. But doing so will usually require you to pay for mortgage insurance. Called PMI for conventional loans and MIP for FHA financing, mortgage insurance is one of those expenses of life you may not like but is necessary for many people. Mortgage insurance is there to reimburse the lender if you fail to pay your loan and default on it. The lender is paid back some of the loan amount. This lowers their risk on lending to people who put less than 20% down. Unfortunately, mortgage insurance can cost more than $1000 per year and sometimes much more, depending upon the size of the loan, type of loan, and your credit.
Let’s Compare FHA MIP to Lender Paid Mortgage Insurance
If you are putting down less than 20%, one of your options instead of paying mortgage insurance each month is to use lender paid mortgage insurance or LPMI. With this program, you will pay a bit higher interest rate each year for the pleasure of not paying mortgage insurance. You can expect to pay an interest rate that is .5% more than the regular rate that other mortgage products offer. But there are several things to think about if you are going to possibly get lender paid mortgage insurance.
On the plus side, you will enjoy a lower mortgage payment each month. Your payment will include your principal, interest, homeowner’s insurance and property taxes, but no mortgage insurance. This will put at least $100 or $200 more in your pocket every month – not a bad deal.
Second, you are having to put less money down on your home. This is especially important for first time home buyers who are not bringing equity to the table from another property. Paying a higher rate for LMPI can make sense in many situations, and it is allowing you to buy a home with a fraction down of what is usually required. That money can be used for fixing up the home or other things.
On the down side of LMPI, you will pay a higher interest rate. Expect to pay at least .5% more and sometimes more than that. This will add up over the years of the loan to be a lot of money. If you plan to stay in the house for 10 years, you will be paying a higher rate the entire time. But if you are going to sell the home in five years, paying a higher rate may make sense for the pleasure of not paying monthly mortgage insurance. Many experts say putting down 5% or less and staying in the home less than 10 years can make sense for paying LPMI.
Also, the economy in early 2018 is doing well, and interest rates are on the way up. We already are seeing rates in the mid 4% range. This means that a mortgage with LPMI tacked on is going to cost you more. If you plan to stay in the home for a long time, you may have difficulty refinancing to a lower rate later because you are paying the higher LPMI rate. The other disadvantage of paying LPMI is that you will pay more if you have average credit below 700. You can however buy points when you close the loan and lower the rate.
LPMI will be with you for life if you decide to stay in the home for 20 years, so keep that mind. LMPI generally is a good option for people who are not making their current house their permanent home.
Other Low-Down Payment Options
If you are unsure if you want to have the higher rate of LPMI, you can consider other government backed loan products that allow only a 3.5% down payment for many people. One of the most popular programs is the FHA loan. This program requires a mere 3.5% down payment for a 580-credit score. FHA loans carry mortgage insurance as well, but this allows you to pay a lower rate than you can usually get in a conventional loan.
Note however that you will probably have to pay for mortgage insurance for at least 11 years if you put down 10% or more, and for the life of the loan if you put down less than that.
Mortgage insurance with FHA loans costs more than with conventional loans. So, you could end up with a payment that is more than with LPMI, even though FHA loans generally carry a lower rate.
The Skinny on LPMI and FHA
LPMI can be a good option for buyers who want to stay in the home for 10 years or less. Beyond that, you will be paying mortgage insurance when you already have 20% equity. Your only option is to refinance that loan, so you no longer are paying the higher LPMI interest rate.
FHA loans can be a desirable choice if you want to put little money down because you will have a very low interest rate. FHA mortgage insurance is still with you though, and often for the life of the loan. So, you would also need to refinance out of the loan to get rid of mortgage insurance. But FHA loans are great for people with lower credit scores as you can get a rate well below market. So deciding which one to choose depends upon your finances, credit and long term plans for the home you are buying.
References: Learn About Lender Paid Mortgage Insurance (LPMI). (n.d.). Retrieved from https://www.thebalance.com/learn-about-lender-paid-mortgage-insurance-lpmi-315657