Lenders Mortgage Insurance (LMI) explained

Saving a deposit can be a major barrier for many would-be home owners. However, there are a number of options for prospective borrowers who are yet to save a 20 per cent deposit, depending on eligibility, one which includes paying for lenders mortgage insurance (LMI).

There are pros and cons to paying LMI, and while LMI might be a good option for some, others may be better off in the long run by saving up a greater deposit before jumping into the property market.

LMI is essentially an insurance policy for lenders that home buyers may have to pay where they do not have a 20 per cent deposit — in other words, where they do not have a loan-to-value ratio (LVR) of less than 80 per cent.

If you want to purchase a property, a lender will typically prefer a minimum deposit of 20 per cent of the property's value. They will then loan you the remaining 80 per cent. For example, this scenario would mean if you were purchasing a home for $500,000, you would need a $100,000 deposit to secure a $400,000 home loan.

If you do not have $100,000, the lender may still approve your application, but is likely to ask you to pay for lenders mortgage insurance to protect them should you not meet your repayments.

If the borrower is unable to meet their repayments, the LMI policy is designed to protect lenders who cannot recover their costs. Lenders mortgage insurance can be paid upfront, or capitalised, which means the fee would be added to the home loan principal.

The loan-to-value ratio (LVR) is a percentage that represents the amount owing and the value of the property. The higher the deposit, the lower the LVR.

For example, if you apply for a home loan of $800,000 with a deposit of $200,000 for a property valued at $1,000,000, your loan to value ratio would be 80 per cent.

Lenders mortgage insurance protects the lender while mortgage protection insurance is designed to help protect the borrower.

Mortgage protection insurance is an optional insurance that may help cover circumstances that prevent you from making repayments such as:

• Injury or illness
• Losing your job
• Death

For example, if you were unable to work for an extended period of time because you were ill, mortgage protection insurance may help cover your loan repayments while you were unable to work. If you’re deciding to take out a mortgage protection insurance policy it’s important to read the product disclosure statement for information about inclusions, exclusions and policy limitations.

Lenders mortgage insurance works as insurance for the lender. Should you be unable to make your repayments, the lender may repossess the property, and sell it, with the LMI policy helping to cover the difference between the amount owing, and the property sale price.

Lenders’ mortgage insurance works as insurance for the lender. Should you find yourself in a position where you are no longer able to repay your mortgage, the lender may choose to repossess the property and sell it to recoup their losses. If the property does not sell for a price high enough to cover the lender’s costs, LMI will help make up the difference and compensate the lender. The LMI insurer may have the right to come after you for the amount that it had to pay out to the lender.

The cost of LMI will be determined by a few different factors, including the amount you borrow, the size of your deposit, whether you are in investor or owner occupier, your income and the lender’s insurer. Let’s explain these in a little more detail, below:

The amount you are borrowing

The more money you borrow, the bigger the risk to the lender. This risk is likely to be factored into the price of the LMI.

The deposit

The size of your deposit will also impact the LMI you pay. Generally, the smaller the deposit the more you will pay in LMI — unless you find you are eligible for some first home buyer government schemes that help eligible people with smaller deposits avoid paying LMI.

Investor or owner occupier

Some insurers may treat LMI differently if the home loan is for an investor or an owner occupier, which could mean the LMI costs are higher for some investors.

Income

Your income may also impact the cost of LMI because this can impact the risk assessment of you as a borrower. If you have a casual or contract job, you may be considered a riskier borrower than a full time employee.

The lender’s insurer

Just like any other financial product, the provider could impact the cost. There are several LMI providers in Australia that may have different premiums and assess risk differently.

It’s also important to remember loan repayments and LMI are not the only cost associated with buying a property. Others to consider include stamp duty, building and pest inspections and conveyancing fees.

Avoiding LMI could save you thousands, and there are a few ways to do so. Here’s some general ideas:

Grow your deposit size

If you are faced with the prospect of paying LMI and want to avoid it, the simplest (but not always the easiest) way to avoid it is to grow your deposit to 20 per cent.

Knuckling down and saving until you have the cash for a 20 per cent deposit might be a good option. However, this can be easier said than done, especially when property prices are rising faster than you can save.

Guarantor home loans

While not everyone has a family member in the position to secure a home loan with their equity, having a loved one act as guarantor on a home loan can help you avoid paying LMI.

Guarantor home loans are when a parent or relative provides part of their equity to guarantee part of your loan, increasing the security on the loan to make up for the shortfall in deposit. If you were unable to make your mortgage payments, however, there is a risk that your guarantor’s credit rating may also be impacted if the loan is listed as a default. They also take on the additional risk of securing the loan should you not make your repayments.

It’s important to do your research before entering into a loan with a guarantor, and for the guarantor to understand all the risks associated with them taking this on.

Government stimulus

The Australian government has various home deposit and ownership schemes to help home buyers get a foot on the property ladder.

The First Home Guarantee Scheme for example, helps first home buyers secure a home loan with a 5 per cent deposit, with the government acting as security for the deposit. Government schemes usually have limited spots available so be sure to keep an eye on both state and federal legislation aiming to help home buyers secure a property.

Compare LMI quotes

If paying LMI is unavoidable in your situation, be sure to shop around to find a competitive option. Different lenders will be associated with different LMI providers, which could result in a different LMI cost.

LMI discounts and deals

Some home loan lenders may advertise discounts or deals on LMI from time to time to attract new customers. These deals are often dependent on your circumstances, strict eligibility criteria and may restrict certain features you may want to access. It’s important to consider all the fees and features of a loan rather than signing up solely to avoid LMI.

LMI can generally be paid in two ways. It can be paid upfront, or added to your home loan (capitalized). If you choose to pay upfront, it may take a sizable chunk out of your deposit, which could potentially mean lowering your price point when searching for a property.

If you choose to add it to your home loan, then you need to account for this in your repayments. LMI can potentially add hundreds to your monthly or fortnightly repayments, which needs to be considered when you calculate what repayments you can afford.

And remember, if the LMI is capitalized you will be charged interest on the total principal of the loan, including the additional amount for LMI. Stamp duty is also charged when paying LMI, as it is for most insurance. This is separate to stamp duty paid on the property. Some quotes will include this in their cost, and some won’t so be sure to check with your lender.

The home loan application process

Applying for a home loan with LMI may also add time to the application process. When you apply for a home loan, the lender needs to assess what you can afford. This means if you will be paying LMI, they need to consider if you can afford the repayments and the insurance costs. Additional time may be added on to the approval process for the LMI insurer to decide whether or not they will accept the insurance risk.

If you choose to add it to your home loan, then you need to account for this in your repayments. LMI can potentially add hundreds to your monthly or fortnightly repayments, which needs to be considered when you calculate what repayments you can afford. And remember, if the LMI is capitalized you will be charged interest on the total principal of the loan, including the additional amount for LMI.

Stamp duty is also charged when paying LMI, as it is for any kind of insurance. This is separate to stamp duty paid on the property. Some quotes will include this in their cost, and some won’t so be sure to check with your lender.

The home loan application process

Applying for a home loan with LMI may also add time to the application process. When you apply for a home loan, the lender needs to assess what you can afford. This means if you will be paying LMI, they need to consider if you can afford the repayments and the insurance costs. Additional time may be added on to the approval process for the LMI insurer to decide whether or not they will accept the insurance risk.