If you’re in the market for a property, it’s likely that your social media pages are flooded with ads for Lenders Mortgage Insurance (LMI). Banks draw you in with promises like ‘Buy a house with as little as 5%’, but fail to give you the bigger picture.
Although LMI was introduced by the Australian government over fifty years ago, it’s become a more common term in recent times due to house prices rising more than the average income, and therefore potential buyers having less savings to use as a deposit.
LMI can be beneficial for some purchasers, however it’s crucial that you understand the short- and long-term risks and challenges involved with it. This blog will explore all things LMI, including how its calculated and its pros and cons.
What is LMI?
Lender’s Mortgage Insurance (commonly known as simply LMI) is designed to protect your bank or lender if you can’t pay back your mortgage in the short- and long-term. For example, if the future sale of your home does not cover the amount you owe on your mortgage, your bank or lender will try to recover the amount owing from your LMI provider. LMI may also kick in if you cannot make your regular mortgage repayments.
Who needs LMI?
LMI is a non-negotiable for property buyers who have a deposit of less than 20% and no guarantor on their loan. It protects the lender if the borrower defaults on their loan to reclaim the missing amount.
How much does LMI cost?
Like any insurance, LMI is not complimentary but rather an additional cost upon your mortgage. The calculation of LMI depends on the loan amount, the Loan to Value Ratio (LVR) and the lender’s LMI premium rates. Other factors can also vary this amount, including whether your deposit is from genuine savings or from a gift or inheritance. Because of this, the cost of LMI will vary and an accurate cost cannot be provided until the lender has been chosen. You can expect to pay in the tens of thousands, however.
Hang on, what is Loan to Value Ratio (LVR) and how does it impact LMI?
LVR is the value of the loan as a percentage of the property’s value. To determine your LVR, divide the loan amount by the price of the property. For example, if you’re using a 5% deposit to purchase a $600,000 property, your LVR will be $570,000 divided by $600,000, which means your LVR is 95%. Your LVR impacts your LMI premium as many lenders use a tiered premium rate which increases with LVR. An LVR of 80% will likely have a lower premium rate compared to an LVR of 90%.
How do I pay LMI?
LMI can be paid upfront as a once-off payment or in regular instalments alongside your mortgage repayments. It’s important to note that combining LMI with your loan repayment will attract interest to the LMI component too, whereas interest won’t be added if it’s paid upfront. Either repayment option is non-refundable.
The pros of LMI
There are two major benefits of LMI. The first is that it allows people to purchase a property sooner than they otherwise would be able to. This is especially important at the moment, whereby house prices are rising more than the average salary.
The second benefit of LMI is that it provides access to better properties. Although you may have enough money in the bank to purchase a property, it may be one in a suburb you’re not completely happy with or one that requires costly renovations just to make it liveable. LMI gives an opportunity for people to have a smaller deposit, and therefore purchase the house of their dreams… or at least something closer to it!
The cons of LMI
The most obvious disadvantage of LMI is the cost. Although this amount varies, LMI typically costs buyers tens of thousands of dollars. In some cases, this could be a similar amount to your deposit. Additional to this, there’s also the added cost of the loan itself. A smaller deposit means a larger loan, and therefore more interest to be paid.
Although a smaller deposit plus LMI might be beneficial for some property buyers, it could be detrimental for others. It’s important to weigh up the long-term costs for your own situation before signing on the dotted line. In some cases, it might be worth waiting a little longer to purchase so you can save more money for your deposit. Remember, it’s LENDERS mortgage insurance – it’s there to protect the lenders, not the borrowers.
