Lenders Mortgage Insurance….what is it and when is it useful?
When buying a home in Australia one of the most significant and often misunderstood costs can be Lenders Mortgage Insurance or LMI. If you’re purchasing a property and contributing less than 20% of the purchase price, then LMI is something you will be likely to encounter. Here’s what you need to know.
What is Lenders Mortgage Insurance?
Lenders Mortgage Insurance is insurance that protects the lender - not the borrower - should the borrower default on their home loan and the resultant property sale not be enough to recover the outstanding balance of the loan. LMI enables lenders to offer home loans to borrowers who have the ability to service a larger loan but don’t have a 20% deposit saved.
How does LMI work?
In most cases, if the purchasers deposit is less than 20% of the purchase price (so not including stamp duty and legals, they are on top) the lender will require them to pay the cost of mortgage insurance. This is a one off premium that can be paid upon settlement or added to the balance of the loan (capitalised). Although the borrower pays the premium, the insurance protects the lender. Additionally, whilst this insurance policy will protect the lender in the event of a forced sale it offers no protection to the borrower; the insurer may still pursue the borrower for any payout they’ve made to the lender.
How much does LMI cost?
The cost of LMI is influenced by various factors, including:
loan amount
deposit size or loan value ratio - the higher the LVR the higher the premium
lender and insurer; each has their own policy and premium schedule
So far it probably sounds as though LMI is something to be avoided - and in many cases it is. However, there are instances when it’s worth paying this cost.
When is LMI a good investment?
LMI can help people to buy sooner and with a smaller deposit; if they’re buying in an area which is growing rapidly, prices may be increasing faster than they are able to save
In a rapidly growing market the cost of LMI may be lower than the growth that is lost whilst the purchaser is saving the extra deposit amount
The purchaser can potentially spend more and get a property that is more suitable to their long term needs, which will save having to sell and buy again in the short - medium term
Investors may prefer paying LMI vs committing capital to deposits as this will help to preserve their cash and grow a property portfolio faster. This aspect will usually be discussed with a licensed financial advisor or accountant and form part of an overarching strategy
Are there exceptions to the 80% LVR rule?
Yes! There are times when loans >80% LVR don’t attract LMI, including:
purchases made under the First Home Buyers Home Guarantee Scheme
certain banks offer selected professions LMI waivers up to 90%. Typically this is for people in the legal and medical professions, however the list varies by lender. This isn’t widely advertised and advice should be sought from your broker.
The final verdict?
As with everything financial the right decision is very individual. Whilst LMI can be a useful tool if well considered it can also be very expensive and add substantially to the cost of the home loan. A professional broker will be able to work through options, obtain quotes and model different scenarios to help each person to make the most informed and appropriate decision.