Define: Lenders Mortgage Insurance

Lenders Mortgage Insurance (LMI) is a type of insurance that protects mortgage lenders from financial losses in the event that a borrower defaults on their home loan and the sale of the property does not cover the outstanding loan amount. LMI is typically required by lenders when borrowers have a deposit of less than 20% of the property’s purchase price, as it provides a safeguard against the increased risk associated with higher loan-to-value ratios. While LMI premiums are paid by the borrower, the insurance policy protects the lender by covering a portion of the outstanding loan balance if the borrower defaults. LMI does not provide any protection or benefit to the borrower and is solely for the lender’s benefit. Borrowers should carefully consider the costs and implications of LMI when purchasing a property with a low deposit, as it can significantly increase the overall cost of borrowing.

Lenders Mortgage Insurance (LMI), also known as Private mortgage insurance (PMI) in the US, is insurance payable to a lender or trustee for a pool of securities that may be required when taking out a mortgage loan. It is insurance to offset losses in the case where a mortgagor is not able to repay the loan and the lender is not able to recover its costs after foreclosure and sale of the mortgaged property. Typical rates are $55/mo. per $100,000 financed, or as high as $1,500/yr. for a typical $200,000 loan.

Mortgage Insurance In The US

The annual cost of PMI varies and is expressed in terms of the total loan value in most cases, depending on the loan term, loan type, proportion of the total home value that is financed, the coverage amount, and the frequency of premium payments (monthly, annual, or single). The PMI may be payable up front, or it may be capitalised onto the loan in the case of a single premium product. This type of insurance is usually only required if the down payment is less than 20% of the sales price or appraised value (in other words, if the loan-to-value ratio (LTV) is 80% or more). Once the principal is reduced to 80% of value, the PMI is often no longer required. This can occur via the principal being paid down, via home value appreciation, or both. In the case of lender-paid MI, the term of the policy can vary based upon the type of coverage provided (either primary insurance or some sort of pool insurance policy). Borrowers typically have no knowledge of any lender-paid MI; in fact, most “No MI Required” loans actually have lender-paid MI, which is funded through a higher interest rate that the borrower pays.

Sometimes lenders will require that LMI be paid for a fixed period (for example, 2 or 3 years), even if the principal reaches 80% sooner than that. Legally, there is no obligation to allow the cancellation of MI until the loan has amortised to a 78% LTV ratio (based on the original purchase price). The cancellation request must come from the servicer of the mortgage to the PMI company that issued the insurance. Often, 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% down payment 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 with an 80% LTV. An 80/10/10 programme uses a 10% LTV second mortgage with a 10% down payment, and an 80/15/5 programme uses a 15% LTV second mortgage with a 5% down payment. Other combinations of second mortgages and down payment 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 were not until 2007. In some situations, the all-in cost of borrowing may be cheaper using a piggy-back than by going with a single loan that includes borrower-paid or lender-paid MI.

LMI/PMI Tax Deduction

Mortgage insurance became tax-deductible in 2007 in the USA. For some homeowners, the new law made it cheaper to get mortgage insurance than to get a ‘piggyback’ loan. The MI tax deductibility provision passed in 2006 provides for an itemised deduction for the cost of private mortgage insurance for homeowners earning up to $109,000 annually.

The original law was extended in 2007 to provide for a three-year deduction, effective for mortgage contracts issued after December 31, 2006, and before January 1, 2010. It does not apply to mortgage insurance contracts that were in existence prior to passage of the legislation.

This site contains general legal information but does not constitute professional legal advice for your particular situation. Persuing this glossary does not create an attorney-client or legal adviser relationship. If you have specific questions, please consult a qualified attorney licensed in your jurisdiction.

This glossary post was last updated: 10th April, 2024.