Fannie Mae Guidelines: Lender-Purchased Mortgage Insurance

What Is Lender-Purchased Mortgage Insurance

Lender-purchased mortgage insurance (LPMI) lets the lender pay for mortgage insurance coverage instead of the borrower. The lender typically builds this cost into the loan's interest rate, so borrowers get a higher rate but no separate monthly mortgage insurance payment.

This arrangement can benefit borrowers who prefer a single monthly payment or want to avoid the hassle of tracking when mortgage insurance can be removed. The trade-off is usually a higher interest rate that lasts for the life of the loan.

Say you're buying a home with 10% down. Instead of paying a monthly mortgage insurance premium of $200, your lender might offer LPMI with an interest rate that's 0.25% higher. You'd pay more in interest each month, but you wouldn't have a separate insurance line item on your payment statement.

Loan Types That Qualify

Fannie Mae accepts LPMI for most loan types, but there's one major restriction. You cannot use LPMI on adjustable-rate mortgages that have a conversion option to fixed-rate loans.

The reason is practical. When borrowers convert their ARM to a fixed rate, the loan terms change significantly. Managing the insurance obligations through that conversion creates complications that Fannie Mae prefers to avoid.

There is one exception. Fannie Mae will consider LPMI on convertible ARMs if the lender uses the "market rate" post-conversion option and assumes all interest rate risk. This puts the burden on the lender to manage the complexity.

Lender Requirements and Obligations

When a lender chooses LPMI, they take on several specific obligations that last for the life of the loan.

The lender must pay all premiums as a corporate obligation. This includes the initial premium at closing and all renewal premiums, whether monthly or annual. Some insurers offer lump-sum premiums that cover the entire loan term, which are also acceptable.

The lender must also increase their servicing compensation by at least the amount of the renewal premium. This requirement ensures the servicer has adequate funds to make ongoing premium payments. If you're using a lump-sum premium plan, this adjustment isn't required since there are no ongoing payments.

Required Disclosures to Borrowers

Lenders must make all disclosures required by law, including those under the Homeowners Protection Act of 1998. This means explaining to borrowers how the insurance works, when it might be cancelable, and how it differs from borrower-paid mortgage insurance.

The borrower needs to understand that with LPMI, they typically cannot request cancellation of the insurance like they could with borrower-paid coverage. The insurance and its cost are built into the loan structure.

You should also explain that the higher interest rate associated with LPMI will remain for the life of the loan, unlike borrower-paid mortgage insurance that can be removed when the loan balance drops sufficiently.

Servicing Transfer Requirements

When servicing is transferred to a new company, the original lender has specific obligations related to LPMI loans.

The lender must provide the new servicer with a complete list of all LPMI loans in the portfolio. This list must identify the applicable premium rates for each loan and explain the payment obligations and procedures.

The lender must also transfer any accrued funds on deposit for future premium payments to the new servicer. If there aren't sufficient accrued funds, the lender must make an appropriate adjustment in the servicing transfer settlement.

Delivery and Documentation

All loans with LPMI must be delivered to Fannie Mae with Special Feature Code 019. This code alerts Fannie Mae that the loan has lender-purchased coverage rather than borrower-paid insurance.

The lender must maintain the insurance coverage until the mortgage is paid in full. Unlike borrower-paid mortgage insurance, there's no automatic termination based on loan-to-value ratios or borrower requests.

Why Lenders Choose LPMI

Lenders often use LPMI as a competitive tool. Some borrowers prefer the simplicity of a single monthly payment, even if it means a higher interest rate. Others want to avoid the complexity of tracking when mortgage insurance can be removed.

From the lender's perspective, LPMI can be profitable if they price the interest rate increase higher than their actual insurance costs. The lender also retains control over the insurance relationship rather than relying on borrower payments.

However, lenders take on the risk that insurance premiums could increase over time while their interest rate remains fixed. They also assume the administrative burden of making ongoing premium payments and managing the insurance relationship.

Common Complications

The biggest challenge with LPMI comes during servicing transfers. If the original lender doesn't properly communicate the insurance obligations or transfer adequate funds, the new servicer may struggle to maintain coverage.

Another issue arises when borrowers don't understand that LPMI cannot be removed like traditional mortgage insurance. This can lead to complaints when borrowers realize their interest rate won't decrease even after building substantial equity.

Lenders also need to carefully track which loans have LPMI to ensure they're making proper premium payments. Missing payments could result in coverage lapses that violate Fannie Mae requirements.

References

For the official guidelines, see B7-1-03: Lender-Purchased Mortgage Insurance in the Fannie Mae Selling Guide.