Lenders Mortgage Insurance (LMI), also known as Private Mortgage
Insurance (PMI), is insurance payable to a lender when taking
out a mortgage. It is an insurance in the case that the mortgagor
is not able to repay the loan, and the lender is not able to
recover its costs after foreclosing the loan and selling the
mortgaged property.
The LMI may be payable up front, or it may be capitalized onto
the loan. This type of insurance is usually only charged if the
downpayment is less than 20% of the sales price or appraised
value (in other words, the LTV or loan to value ratio should
be 80% or less). Once the principal reaches 80%, the LMI is no
longer required. Cancelling mortgage insurance can be a difficult
process. Sometimes lenders will require that LMI be paid for
a fixed period, even if the principal reaches 80%.
The cancellation
request must come from the Servicer of the mortgage to the PMI
company who issued the insurance. Often times the Servicer will
require a new appraisal to determine the LTV. The cost of mortgage
insurance varies considerably based on several factors which
include: loan amount, LTV, occupancy (primary, second home, investment
property), documentation provided at loan origination, and most
of all, credit score.
If a borrower has less than the 20% downpayment needed to avoid
a mortgage insurance requirement, they might be able to make
use of a second mortgage (sometimes referred to as a "piggy-back
loan") to make up the difference . Two popular versions
of this lending technique are the so-called 80/10/10 and 80/15/5
arrangements. Both involve obtaining a primary mortgage for 80%
LTV. An 80/10/10 program uses a 10% LTV second mortgage with
a 10% downpayment, and an 80/15/5 program uses a 15% LTV second
mortgage with a 5% downpayment.
Other combinations of second
mortgage and downpayment amounts might also be available. One
advantage of using these arrangements is that under United States
tax law, mortgage interest payments may be deductible on the
borrower's income taxes, whereas mortgage insurance premiums
are not. As such, even though the additional cost of a higher
interest rate second mortgage might be similar to the cost of
mortgage insurance, the borrower may see a reduction in total
costs when the tax benefits are considered.
Factors Affecting the Choice Between Second Mortgage and Mortgage Insurance
- Interest rate on the second mortgage relative to the rate on the first: The smaller the difference in rate between the two mortgages, the greater the advantage of the combination relative to the single loan.
- Term on the second mortgage relative to the term on the first: Shorter term loans pay down the balance faster than longer term loans. Since the second mortgage has a higher rate than the first, the faster the second is paid off relative to the first, the greater the advantage of the combination compared to the single loan.
- Your tax bracket: Because the combination loan enjoys a larger tax write-off, the combination is most advantageous for borrowers in the highest tax bracket.
- Closing costs: With one loan closing, closing costs should be the same for one loan or two. But if the second mortgage is from a different lender and requires a separate closing, the combination will have higher closing costs.
- Expected appreciation rate: Borrowers can request that their mortgage insurance be terminated when the loan balance reaches 80% of the home’s appreciated value. This means that the higher the expected appreciation rate, the less the advantage of the combination.
- Other factors: How long you expect to remain in the home and the rate of return you can earn on investments also affect how your choices shake out.
