You know that you need a down payment for a home when you're applying for a mortgage. But did you know that a small down payment may mean you need to purchase lenders mortgage insurance (LMI)? Learn what LMI is, how it works, and who needs it.
What is LMI?
Mortgage insurance protects your lender if you default on your mortgage. Home buyers who are putting down less than 20 percent will be required to purchase this insurance. If you own a home and you decide to refinance, you may need to purchase LMI if your established home equity is under 20 percent.
You'll pay a one-time premium for LMI, which is expressed as a percentage ranging from 0.6 to 4.5 percent of your mortgage. This premium can be paid upfront to keep your interest down, or added to your mortgage where it will increase the premium. LMI, also called mortgage loan insurance, offers no protection to home buyers. It is only intended to protect the lender from a buyer who stops making payments.
How Does LMI Work?
Home buyers who put down less than 20 percent of the home value must take out mortgage loan insurance for the difference between their down payment and 20 percent. Home buyers with poor credit, or home buyers who are self employed, may be required by their lender to take out mortgage insurance even if they are putting down 20 percent.
Your mortgage lender will let you know during the mortgage application process if you are required to take out LMI. You don't need to apply for mortgage loan insurance. If it's needed, your lender will make the arrangements. The LMI premium varies by the size of a down payment. If a home buyer is placing 5 percent down—and borrowing 95 percent—they will pay 4 percent in mortgage loan insurance premiums. If they are putting 15 percent down—and borrowing 85 percent—the premium would be 2.8 percent.
When Do You Need LMI?
There are several reasons why you would need LMI, or mortgage lenders insurance. If you are buying a home and you are going to have less than a 20% down payment, LMI is required to protect your lender in the event you default on the loan. If you have a poor credit score, your lender can require you to purchase LMI throughout the life of the loan. It can mean the difference between getting a mortgage with your poor credit score, or being denied the ability to purchase a home. In the event you want to refinance your home and you will have less than 20% equity when you are done, you will need to include LMI in your loan.
To determine the true cost of a mortgage loan insurance premium, multiply the amount of a mortgage by the interest rate. If you are borrowing $300,000 and must pay 2.8 percent in LMI, the true cost of the LMI premium is 2.8 percent of $300,000, which is $8,400. If a lender quoted 4 percent in LMI, buyers would pay 4 percent of $300,000 or $12,000. Residents of Ontario, Manitoba, and Quebec Province are taxed on their mortgage loan insurance premiums; this tax cannot be added onto the mortgage but must be paid when buyers receive the mortgage loan.
As this example illustrates, it's worthwhile to place more money down if that's an affordable option. Putting more money down can also reduce the cost of the mortgage loan interest, saving more money over time when buying your Springbank Hill home. It's also best to pay LMI up front; adding LMI premiums to the mortgage amount increases the mortgage by that amount. Buyers will pay more in interest every month for the life of the mortgage.
If you have any questions about mortgage loan insurance, ask your mortgage lender during the application process. Your mortgage lender can make sure you understand the way LMI works and whether or not you need it. Whether you decide to look for cheaper homes where you'll be able to put down more of a down payment, delay your home purchase until you've saved more money, or proceed with a mortgage that requires LMI, you'll feel prepared when you understand how LMI works.