Why Do You Need It?
Mortgage insurance (MI) is required by the lender for any loan that doesn’t have an LTV (loan to value) of 80% or less. If the borrower is buying a home for $100k and has a down payment of 10%, the LTV is 90%. For any loan over 80% the lender requires BPMI (borrower paid mortgage insurance). The insurance is provided by a third party vendor, one of the most popular providers is called Radian. The insurance cost can vary depending on down payment, purpose of loan, location of property and the borrowers credit score. If a borrower has an LTV of 95% the insurance would be more expensive than a borrower with 15% down.
Who Does the Insurance Benefit?
The lender. In the event the borrower defaults or foreclosures the insurance company will reimburse the lender for the portion of the insured amount over 80% LTV, this way the lender would offset their loss on funds over the 80% LTV threshold. A lot of borrowers get this type of insurance confused with the mortgage insurance that could pay off the loan in the event of a death. There used to be companies that provided this type of insurance but we haven’t seen any in quite a few years. If borrowers ask about it we typically suggest the borrower talk to a life insurance agent to offset the mortgage balance in case of such an event.
Borrower Paid Mortgage Insurance (BPMI) vs. Lender Paid Mortgage Insurance (LPMI)
When the borrower pays the insurance its called BPMI. The benefit to borrower paid is the insurance can eventually be cancelled. If the borrower refinances the property and the LTV becomes lower than 80% the BPMI will be eliminated. Another way to eliminate the MI would be to pay down the principal balance of the loan until it reaches 80% of the original purchase price, in most cases. There are other guidelines and rules involved in removing MI in relation to single family residences, two to four unit properties, payment history etc. The borrower would call their mortgage servicing company and they would assist in terminating the monthly expense.
When the lender pays the insurance its called LPMI. During the housing recession in the mid 2000’s their were quite a few MI companies that went under. The ones that made it through the crisis either had very high rates or they wouldn’t offer MI at high LTV’s, example 95%. The lenders needed to have way to insulate themselves and still offer high LTV loans, so they increased the interest rate. LPMI is basically an adjustment to your interest rate which will raise your interest rate but the mortgage could have a lower monthly payment depending on the borrowers socre and LTV.
Hypothetical Example, a borrower qualifies for a 95% LTV conventional loan and needs MI. The interest rate is 4.25% with BPMI of $250 per month. Using LMPI the lender would raise the interest rate to 4.75% but not charge the additional $250 per month. Since the extra .5% in rate is amortized over 30 years the monthly payment could be less. The negative about LPMI is it can’t be removed from the interest rate so it can never be cancelled unless the borrower refinances the loan.
What is Better BPMI or LPMI?
Depends. If a borrower is purchasing a starter home or a home for short term use, it may be better to utilize the LPMI. More than likely the borrower will not pay the loan down to 80% of the principal balance in five years or if its a starter home the plan may be to rent the home after a few years and have the tenant make the payment. If the borrower plans in living in the home long term typically the best choice is BPMI so the expense can be eliminated, the total monthly cost lowered and the loan would not need to be refinanced.
Fannie Mae (FNMA) has an industry guide available to mortgage brokers, bankers, investors and lenders. It is called the FNMA Selling Guide. The guide goes into specific detail in reference to mortgage insurance including how and when it can be cancelled. If would like to read it let us know and we would be happy to send you the information.