Lender Paid PMI - where's the catch?
February 21, 2006 3:50 PM Subscribe
I'm about to buy my first house and I'm shopping around for a mortgage. The best deal so far is a mortgage where the lender pays for the mortgage insurance. I'm aware of using 80/XX loans to avoid paying PMI but I've never come across Lender Paid PMI. What exactly is it and what's the catch?
The mortgage with the lender paid PMI is about a half point higher than the traditional mortgage. But the PMI-free mortgage is about $30 or so per month cheaper. This seems like a great alternative to the 80/XX loans. But there has to be a catch. Realistically we dont expect to spend the rest of the lives in the new house so there's a good chance we will be moving before we would be able to remove the PMI due to changes in house prices. Anyone know what gives? Has anyone used them in the past? Are there any special questions related to this type of loan I should be asking the lender?
The mortgage with the lender paid PMI is about a half point higher than the traditional mortgage. But the PMI-free mortgage is about $30 or so per month cheaper. This seems like a great alternative to the 80/XX loans. But there has to be a catch. Realistically we dont expect to spend the rest of the lives in the new house so there's a good chance we will be moving before we would be able to remove the PMI due to changes in house prices. Anyone know what gives? Has anyone used them in the past? Are there any special questions related to this type of loan I should be asking the lender?
Response by poster: Yeah that's what I meant (too much thinking about this is slowly making my brain mush). First time home owners only stay in their first house for a few years (3 or so?), I dont think we'd be able to get below the 20% point that quick.
The interest rate would be 0.5% higher.
I will be doing the math but I am wondering if anyone with experience with this type of loan has any idea opinions.
posted by schwa at 4:20 PM on February 21, 2006
The interest rate would be 0.5% higher.
I will be doing the math but I am wondering if anyone with experience with this type of loan has any idea opinions.
posted by schwa at 4:20 PM on February 21, 2006
What's wrong with the traditional 15/30 fixed? There are no catches, gotchas, or fuzzy math involved. It's straightforward and perfect for first-time homeowners.
Check out what the FHA is offering - they've got plans specific for first-time home owners.
All these gimmick mortgages give me the willies.
posted by unixrat at 7:10 PM on February 21, 2006
Check out what the FHA is offering - they've got plans specific for first-time home owners.
All these gimmick mortgages give me the willies.
posted by unixrat at 7:10 PM on February 21, 2006
I don't have any experience taking out this type of loan, but I've done lots of analysis on mortgage companies, so here are my random thoughts...
I wonder if the mortgage company has done an arbitrage here. They know you will pay X for PMI and that if they substitute lender-paid PMI for a higher interest rate you will save some money. Perhaps their cost for PMI is less than what you would have paid (I don't why - perhaps they're insuring a whole portfolio at once and they cut a deal with the insurance company) and the extra interest rate bump results in a positive trade-off.
Also, many mortgage are sold to larger institutions and/or into large securitized pools - your mortgage originator may be responding to demand for certain loan characteristics. And finally, your mortgage originator may be manipulate their numbers. When analyzing a pool of mortgages, the gross yield is one of the first statistics that people look at. So, your mortgage originator may be trying to inflate this number by giving away some profitability.
posted by mullacc at 7:20 PM on February 21, 2006
I wonder if the mortgage company has done an arbitrage here. They know you will pay X for PMI and that if they substitute lender-paid PMI for a higher interest rate you will save some money. Perhaps their cost for PMI is less than what you would have paid (I don't why - perhaps they're insuring a whole portfolio at once and they cut a deal with the insurance company) and the extra interest rate bump results in a positive trade-off.
Also, many mortgage are sold to larger institutions and/or into large securitized pools - your mortgage originator may be responding to demand for certain loan characteristics. And finally, your mortgage originator may be manipulate their numbers. When analyzing a pool of mortgages, the gross yield is one of the first statistics that people look at. So, your mortgage originator may be trying to inflate this number by giving away some profitability.
posted by mullacc at 7:20 PM on February 21, 2006
Response by poster: The problem with the staight 15/30 year fixed is that I'd still be paying a chunk of cash each month for PMI. Removing it via a 80/XX mortgage or via this lender paid scheme seems like a good idea. I'll be able to reduce the mortgage payment by about 5% by just choosing one mortgage over another. What's not to like about that? You tell me.
posted by schwa at 9:05 PM on February 21, 2006
posted by schwa at 9:05 PM on February 21, 2006
schwa, you're getting a lot of advice here without having mentioned a couple of critical characteristics of the loans you're being offered, so tread carefully.
Here are a few of things to find out (just ask the lender/broker,) or bring us up to speed on if you already know, so it'll be easier to do a straight comparison:
First, how is the am schedule on the lender-paid PMI loan any different than a traditional fixed-rate loan, apart from the interest rate being higher? Does the interest rate change? Are you comparing it to a loan of comparable term?
Second, is there any differential in closing costs, up-front points, application fees, underwriting fees, or any other one-time costs (apart from the PMI payments) between the two products?
Finally, are there any other nuances like prepayment lockout periods that apply to one but not both loans? Depending on your state, this might not be an issue.
Other things to consider, depending on what you find out:
1) Tax implications: If the loan is big enough so that you end up itemizing your deductions at the end of the year (probably,) and the lender-paid PMI loan is structured so that all your payments look like principal and interest to the tax man (ask,) it'll offer the added benefit of slightly higher deductions at tax time than by going the loan plus PMI route on a comparable loan. This is assuming that Congress hasn't changed the tax code in the past couple of years to allow PMI deductibility (find this out, too.) If this is the case, that's even more of a plus for the lender-paid PMI route. This might be part of the angle that makes it an attractive product for lenders to offer -- basically it would constitute a government subsidy of your PMI.
2) Length of stay/size of payments: Depending on the underwriting insurer or policy, your PMI payments may be scheduled to decline over time. Find this out so you can make a better comparison between the two products after year one. Also, it isn't uncommon to require an initial payment of several months worth of PMI up front. This might be an issue if you're currently stretched thin on cash. So confirm the PMI payment schedule as well as expected payment size.
3) Also are you getting these quotes from a single lender, or are you working with two lenders, with each offering a different product? You should be getting quotes from multiple lenders. If you are, each lender may be (I'm being generous here -- I should say "is almost certainly") offering you the product they will get paid the most for selling. Get them to play off each other by asking each for a quote on the product they AREN'T plugging now -- it could turn out that one beats the other on both products.
Contact me via email if you want to look at this in a little more depth -- I used to value mortgage-related assets for a living.
mullacc, I think you're on to the angle. 50 bps is the right order of magnitude for consumer-paid PMI costs, so I'd guess the lender probably has negotiated a variable PMI over the loan life at a better rate than is normally offered to the borrower. I'm sure they've figured out a way to avoid secondary-market complications (though it isn't really the borrower's concern, anyway.) And there's the tax angle mentioned above too, which might mean they can sell the lender-paid PMI product to borrowers even if the scheduled monthly payments are the same or slightly higher than the loan plus separate PMI structure.
The value of the product as a whole (pass-through plus spread) will be dependent on a lot of stuff. A good part of valuing mortgage-related assets involves note-rate-related prepayment assumptions, so I would suspect lender-paid PMI loans are sold into different pools than more traditional ones so that the prepayment assumptions applied aren't higher than they need to be (which would tend to depress the pools' market values.)
posted by Opposite George at 11:24 PM on February 21, 2006
Here are a few of things to find out (just ask the lender/broker,) or bring us up to speed on if you already know, so it'll be easier to do a straight comparison:
First, how is the am schedule on the lender-paid PMI loan any different than a traditional fixed-rate loan, apart from the interest rate being higher? Does the interest rate change? Are you comparing it to a loan of comparable term?
Second, is there any differential in closing costs, up-front points, application fees, underwriting fees, or any other one-time costs (apart from the PMI payments) between the two products?
Finally, are there any other nuances like prepayment lockout periods that apply to one but not both loans? Depending on your state, this might not be an issue.
Other things to consider, depending on what you find out:
1) Tax implications: If the loan is big enough so that you end up itemizing your deductions at the end of the year (probably,) and the lender-paid PMI loan is structured so that all your payments look like principal and interest to the tax man (ask,) it'll offer the added benefit of slightly higher deductions at tax time than by going the loan plus PMI route on a comparable loan. This is assuming that Congress hasn't changed the tax code in the past couple of years to allow PMI deductibility (find this out, too.) If this is the case, that's even more of a plus for the lender-paid PMI route. This might be part of the angle that makes it an attractive product for lenders to offer -- basically it would constitute a government subsidy of your PMI.
2) Length of stay/size of payments: Depending on the underwriting insurer or policy, your PMI payments may be scheduled to decline over time. Find this out so you can make a better comparison between the two products after year one. Also, it isn't uncommon to require an initial payment of several months worth of PMI up front. This might be an issue if you're currently stretched thin on cash. So confirm the PMI payment schedule as well as expected payment size.
3) Also are you getting these quotes from a single lender, or are you working with two lenders, with each offering a different product? You should be getting quotes from multiple lenders. If you are, each lender may be (I'm being generous here -- I should say "is almost certainly") offering you the product they will get paid the most for selling. Get them to play off each other by asking each for a quote on the product they AREN'T plugging now -- it could turn out that one beats the other on both products.
Contact me via email if you want to look at this in a little more depth -- I used to value mortgage-related assets for a living.
mullacc, I think you're on to the angle. 50 bps is the right order of magnitude for consumer-paid PMI costs, so I'd guess the lender probably has negotiated a variable PMI over the loan life at a better rate than is normally offered to the borrower. I'm sure they've figured out a way to avoid secondary-market complications (though it isn't really the borrower's concern, anyway.) And there's the tax angle mentioned above too, which might mean they can sell the lender-paid PMI product to borrowers even if the scheduled monthly payments are the same or slightly higher than the loan plus separate PMI structure.
The value of the product as a whole (pass-through plus spread) will be dependent on a lot of stuff. A good part of valuing mortgage-related assets involves note-rate-related prepayment assumptions, so I would suspect lender-paid PMI loans are sold into different pools than more traditional ones so that the prepayment assumptions applied aren't higher than they need to be (which would tend to depress the pools' market values.)
posted by Opposite George at 11:24 PM on February 21, 2006
I bought my first house last year with one of these lender paid PMI loans. Mine was called 100% Financing.
For my situation, since I did not have any money to put on a down payment and money coming from a prior house sale, I only had two options:
1. 80/20: 80% on a 30 year fixed and 20% on a second mortgage that was interest only.
2. 100%: 100% financed at 30 year fixed with 0.5% higher interest rate.
The 80/20 had lower closing costs because the 100% also included a little less than a point extra in closing. Monthly payments between the two were almost equal.
At the time, the 100% interest rate was 6.25%. Yes, people have gotten lower, but in the grand scheme of things it is a decent rate. I'm not rich and I don't have piles of cash, so of course I will not get the lowest rates. Fair enough in my book.
Of the two options, the real question is how long do you plan to stay in the house? I am planning to stay for at least 5 years and to make extra payments to principal, so the 100% option made more sense for me.
If you plan to move sooner than 5 years or don't have much upfront money at all, then you may want to think about the 80/20.
posted by Sasquatch at 8:43 AM on February 22, 2006
For my situation, since I did not have any money to put on a down payment and money coming from a prior house sale, I only had two options:
1. 80/20: 80% on a 30 year fixed and 20% on a second mortgage that was interest only.
2. 100%: 100% financed at 30 year fixed with 0.5% higher interest rate.
The 80/20 had lower closing costs because the 100% also included a little less than a point extra in closing. Monthly payments between the two were almost equal.
At the time, the 100% interest rate was 6.25%. Yes, people have gotten lower, but in the grand scheme of things it is a decent rate. I'm not rich and I don't have piles of cash, so of course I will not get the lowest rates. Fair enough in my book.
Of the two options, the real question is how long do you plan to stay in the house? I am planning to stay for at least 5 years and to make extra payments to principal, so the 100% option made more sense for me.
If you plan to move sooner than 5 years or don't have much upfront money at all, then you may want to think about the 80/20.
posted by Sasquatch at 8:43 AM on February 22, 2006
This thread is closed to new comments.
Realistically we dont expect to spend the rest of the lives in the new house so there's a good chance we will be moving before we would be able to remove the PMI due to changes in house prices.
Not sure what this means. My understanding is, you're only required to carry mortgage insurance until the remaining balance on your loan is less than or equal to 80% of the total cost of the home. You'll have to pay the cost of a higher interest rate forever. You'd need to do the math to see which saves you more money.
posted by designbot at 4:08 PM on February 21, 2006