Buying a home with a down payment of less than 20 percent often requires mortgage insurance. Understanding how lender's mortgage insurance works, and what they may be expected to pay for it, is an important step for people interested in purchasing a home.
What Is Lender's Mortgage Insurance?
People keep home insurance so that if something happens to their homes, they do not have to pay a lot of money out of pocket to fix it. Similarly, lenders keep mortgage insurance to protect themselves in the event that a borrower fails to pay back the loan. Lender's mortgage insurance (LMI), also called “mortgage default insurance,” provides the lender with a guarantee if the homeowner defaults. The organization holding the insurance policy provides the lender with compensation for the lost funds, and may also enforce the loan terms with the borrower.
How Is LMI Calculated?
Lenders look at LMI in terms of the risk presented by a particular borrower. People who put a lot of money in a down payment for a home are generally considered to have a lower risk. Home buyers with high-ratio mortgages, loans greater than 80 percent of the purchase price of the property, represent a higher risk for the lender. The amount of the LMI that the lender has to pay depends on the amount the borrower is financing, as well as the other aspects of their loan application. The lender pays for the insurance and often passes the cost on to the buyer. The total cost of the LMI represents a few percentage points, and is higher for those with the riskiest loans.
What Affects the Cost of LMI You Have to Pay?
The amount of money that a homeowner pays for LMI is usually based on a percentage of the home. Typically, LMI costs between 2.8% and 4% of the mortgage. The larger the mortgage, the more money the home buyer will spend on LMI.
Home buyers who want to keep their bills down can do so by limiting the amount they borrow for the house. Smart shopping, looking in less expensive areas and shopping with a real estate agent are all ways that home buyers can limit the money that they owe for LMI on a monthly basis.
For buyers, the best way to find out what percentage of their mortgage they can expect to pay for their LMI is to contact their lender. The lender can help the home buyer by telling the buyer the percentage and helping the buyer make projections based on different mortgage amounts.
How Much Is Due at Closing?
Depending on the lender, home buyers usually have options for how they want to pay for the LMI. In many instances, buyers ultimately decide to have the LMI premium wrapped into their mortgage loans, to minimize their closing costs. They should keep in mind that this could increase their monthly mortgage payment, possibly by a significant margin. Many people prefer to pay the premium at closing, if they can. This helps avoid the additional cost of interest tacked onto the LMI wrapped into the loan. However people opt to handle LMI, they should see if they have to pay provincial sales tax on it, as well. That payment is due at closing.
Are All Loans Subject to LMI?
As a very general rule, any mortgage loan that has a down payment less than 20 percent could have LMI expenses attached to it. However, not every loan qualifies. For example, people who buy a home with a sale price over $1 million may not be able to get mortgage insurance for it. Loans that amortize over a period longer than 25 years do not qualify for LMI. In addition, although the lender opens the insurance policy, the buyer must qualify for it just like the mortgage. If the insurer rejects the borrower, the lender must find another insurer. In these cases, homeowners may be expected to make a down payment of at least 20 percent, or consider applying to a different lender.
The home buying process involves a number of expenses and fees related to the opening of the mortgage. Copperfield home buyers who make a smaller down payment may be subject to LMI, paid at closing or in the mortgage loan. Knowing what they will have to pay and when will help potential borrowers prepare for buying a home.
Justin Havre is the top producing REALTOR® with RE/MAX First, Canada's very first RE/MAX brokerage. Calgary real estate is his passion; Justin specializes in Southwest & Northwest Calgary homes for sale. He can be reached at 403.217.0003 or contacted through this site.