Most people in the market for a new home or investment property would have come across the term, Lenders Mortgage Insurance or LMI. So why does it have such a bad reputation and why will people do almost anything to avoid paying it?
It may not be as bad as people think and there are situations where it can be used to your advantage.
What exactly is Lenders Mortgage Insurance?
The Australian Government introduced LMI more than 50 years ago to encourage banks to lend more than 80 per cent of a property’s value. This allowed people with smaller deposits to get into the market.
Put simply, it’s an insurance policy designed to protect the lender from financial loss if the borrower can’t afford to meet their home loan repayments. It kicks in when you borrow more than 80 per cent of a property’s purchase price. The cost is then passed on to the home buyer by the lender as a fee at the time of settlement.
Therefore, LMI protects your bank if the borrower defaults on the loan and there is a shortfall when the property is sold. It does not protect the borrower.
Does LMI provide any advantages for borrowers?
Lenders Mortgage Insurance enables borrowers to get into the housing market with a smaller deposit.
If property prices are increasing, getting into the market so you are on board for price growth could be more beneficial than being forced to wait and pay much more for a property.
You may hardly feel the cost in your actually monthly repayments. In most cases, LMI is small in comparison to the loan size and therefore it may only slightly increase your monthly loan repayments.
Does LMI provide any disadvantages for borrowers?
Lenders Mortgage Insurance can limit how much of your loan funds are used toward the actual purchase price and costs when buying a home. For example, a lender may give you a 95% loan, but with Lenders Mortgage Insurance you may only utilise 92% of those funds toward the actual funds required to purchase the property.
LMI is also capitalised in most cases, meaning the fee is loaded on top of your home loan amount. This will obviously incur interest, and over time that can really add up!
You may be relegated to more expensive home loan product. In this day and age, lenders price their products in line with how much is being borrowed against the property price. The lower that percentage, the lower your interest rate is going to be. With a borrowings above 80% and loaded with LMI, you might be paying more in terms of rate.
Is it better to save the 20 per cent or pay LMI?
This is very much up to the individual, the market that they are purchasing in, and what costs they are willing to pay. Do the financial costs of LMI outweigh the non financial benefits?
Like stamp duty, LMI is calculated on a sliding scale: the higher your loan amount and loan to value ratio (LVR), the higher the premium. The size of the deposit, the purchase price and the type of loan taken out will also be determining factors.
LMI rates just like interest rates, vary from bank to bank so it is worth shopping around for banks with a lower LMI premium. There are LMI calculators online to assist you with calculating an estimated premium.
Are there any ways to avoid LMI?
Aside from applying to have LMI waived on a case-by-case basis with your lender, the best way to avoid LMI is by having a deposit of 20% or more of the purchase price of the property. Another alternative is using a Government Guarantee or Family Guarantee loan. This is usually most relevant to the those buying their first home. Some of the larger lenders will allow parents to act as a guarantor for the purchase, which will eliminate LMI.
Call one of our Mortgage Brokers today on 8300 8300 to assist you with any Lenders Mortgage Insurance questions that you may have!