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What is (LMI) Lenders Mortgage Insurance?

When you’re a first home buyer, there’s a lot to think about: where and when to buy, how much of a deposit to aim for, how to minimize your interest payments and how to select the type of home loan that best suits your needs – and that’s just for starters. Probably one of the least understood aspects of buying a home in Australia is something called lenders mortgage insurance (LMI). According to a Mortgage Choice survey, only 40% of prospective home buyers in this country understand what LMI is: an insurance policy designed to protect the lender if a borrower is unable to pay their mortgage.[1]

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How does lenders mortgage insurance work?

The first thing to know about LMI is that it’s not the same thing as mortgage protection insurance. Many people confuse the two but they’re totally different products. Mortgage protection insurance is an optional type of policy aimed at protecting home owners and their loved ones from the financial impact of unexpected events that might affect their ability to pay back their home loan, such as involuntary job loss, injury, illness or death.[2]

Lenders mortgage insurance sounds similar but is entirely different: it’s designed to protect the lender from financial loss if the borrower defaults on their home loan. If a borrower can’t make their home loan repayments and the sale of the home doesn’t equal the unpaid value of the loan, LMI provides a safety net for the lender, who can claim on the policy to make up the difference.

Who pays for LMI?

Certain borrowers are required to pay for LMI. Although lenders’ home loan rules vary, you can generally expect to have to pay for LMI if the deposit on your home loan is less than 20% of the total property value. Put another way, if your loan-to-value ratio (LVR) is more than 80%, there’s a good chance the lender will require you to pay for an LMI policy.

You can either pay the LMI amount upfront or have it added to your home loan, in which case you’ll usually be charged interest on it over the term of the loan by the lender. Typically, LMI premiums aren’t refundable, so you won’t be able to transfer your lenders mortgage insurance to another lender if you decide to switch home loan providers at a later time.  Where necessary, the Lender arranges this cover.

How much LMI will I pay?

Several factors can affect the total cost of lenders mortgage insurance. These include:

How much deposit you’re putting down –

When it comes to reducing the cost of your LMI, the best weapon is a bigger deposit. The difference between paying a 5% deposit and a 15% deposit on a new home can have a massive effect on your LMI premium, for example. A quick check on Genworth’s handy online LMI premium calculator (as of Nov. 2020) shows that a hypothetical first home buyer putting a 5% deposit on a loan of $500,000, with a loan term of up to 30 years, would pay around $14,872 in upfront LMI costs. However, the same buyer paying a 15% deposit on that same property with the same loan term would only be looking at an LMI cost of around $4,712 – more than $10,000 less.[3]

The home loan amount –

The cost of LMI is directly tied to the amount being borrowed because the more money the lender provides you in the form of a home loan, the more financial risk they’re taking. So, if you don’t meet the deposit requirements, the bigger the loan, the more you’ll pay for lenders mortgage insurance.

The LMI insurance provider –

In Australia, the two major LMI providers are QBE and Genworth.[4] A few other lenders offer borrowers their own version of LMI, which they often call something else (e.g. RAMS Risk Fee, Commonwealth Bank Low Deposit premium, etc.). As with all forms of insurance, premium costs will vary between different providers.

Your employment status –

Lenders will assess your risk as a borrower based partly on your job situation. Being in stable full-time employment can help your chances, while sporadic part-time work might be perceived as a negative. Being employed in certain professions can also work in your favour. Under normal circumstances, LMI is required if the loan-to-value-ratio is more than 80% but it may be waived for LVR’s up to 90% if the borrower is a professional in specific fields such as medical, legal, accounting and others. If this applies to you, you’ll also need to be a member of the relevant professional association. If in doubt as to whether you qualify for an LMI discount or exemption, consult a mortgage expert for advice.[5]

Whether the home is for residential or investment purposes –

Many lenders and insurers take the property’s intended use into account when calculating LMI cost. Using Genworth’s LMI Premium Estimator once again to toss in some hypothetical values, it quickly becomes evident that an investment borrower will pay considerably more for their LMI premium than an owner-occupier. This is because the lender’s perception is that you’re less likely to default on your home loan if you’re living on the property.

How to avoid (or reduce) lenders mortgage insurance

LMI can be expensive, so anything you can do to either trim down its cost or dodge it completely will help your budget. Here are some of the best ways to put a dent in LMI:

Choose your home loan lender carefully –

Check comparison websites to get an overview of what’s available in the home loan space and then narrow down your choices to at least three reputable lenders offering the type of loan you’re after. Decide whether to go with fixed or variable interest, determine if you’ll want an offset account or redraw facility and make sure you understand all the fees that come with your loan.

If you’re new to property buying, don’t hesitate to consult a financial advisor if you have any questions. Because of the huge amounts of money involved, shopping around for the best deal is absolutely essential. Getting the right home loan can potentially save you tens of thousands of dollars in the long run. 

Enlist the help of a guarantor –

A guarantor is a person who financially guarantees (takes responsibility for) all or part of your home loan if you’re unable to make repayments. For young, first-time home buyers, a parent or other family member typically serves as a guarantor. Being a guarantor is a serious matter, since that person risks their own assets and savings in acting as your legal guarantor.

Your guarantor only comes into play if you fail to make repayments. Each lender will have different eligibility requirements for guarantors but in general, they look for people with a stable income, a healthy credit score and a solid level of property equity that can serve as security. The lender will weigh up your risk as a borrower as well as the financial status of your guarantor in deciding whether to approve you for a guarantor home loan. Since a guarantor lessens risk to the lender, your LMI cost is reduced.

Apply for the First Home Loan Deposit Scheme –

Eligible first home buyers may be able to apply for the government’s new First Home Loan Deposit Scheme (FHLDS), which aims to assist those entering the property market for the first time. Under this scheme, the Australian government guarantees 10,000 low-deposit loans per year for low- and middle-income earners who have saved a deposit as little as 5% of the property’s value. You can find out more about FHLDS (including eligibility requirements) here.

As an economic response to COVID-19, the government has also created the Homebuilder program. This provides a grant to eligible owner/occupiers to build a new home or substantially renovate an existing one. The scheme has currently been extended until 31 March 2021. For the most up-to-date information about Homebuilder, go to: treasury.gov.au/coronavirus/homebuilder.

Beef up your deposit –

One of the simplest ways to avoid paying for lenders mortgage insurance is to come up with a deposit that’s 20% or more of the property’s value. While this isn’t always easy, it has some real advantages. By fronting up with a larger deposit, you (a) represent less risk to the lender, (b) can negotiate a lower interest rate, (c) pay less interest over the course of the loan and (d) end up with smaller repayments, since you’re borrowing less.[6]

Which is better – paying for LMI or building up a larger deposit?

Unfortunately, there’s no easy answer to this question – it all depends on your financial circumstances and the state of the property market. It’s a tricky decision of timing - if you wait until you’ve saved up a 20% deposit before you buy, you can avoid paying for LMI entirely. But if property prices happen to rise while you’re saving up, you could end up paying more for your new home in the end – or miss out entirely on the house you really want. Paying a smaller deposit and shelling out for LMI has the advantage of getting you into the property market sooner, which means you can grab your dream home before the price goes up. The downside is that LMI is yet another expense in the home-buying process that you might prefer to circumvent. Obtaining LMI approval can also extend the whole home loan application process. 

Keeping a close eye on housing market trends can help you work out your best plan of attack regarding a property deposit. If prices are stable or falling, you might decide to save like crazy and put off your purchase until your deposit has ‘fully grown up’. On the other hand, if the market is powering ahead and you feel prices may rise faster than you can save, then jumping into a house price you can afford right now and paying for LMI could work out cheaper than trying your luck in a strengthening market 18 months down the track. Becoming a successful first home buyer is far from an exact science: it often comes down to judgement, timing, diligent saving and a fair bit of luck.[7]

The bottom line

It’s a bit simplistic to think of LMI as either a good or a bad thing – in truth, it will always be a bit of both, depending on your home buying goals, financial situation and what the Aussie property market is doing when you’re looking for your first home. For many people, it may seem silly to be paying thousands of dollars for a type of insurance that doesn’t provide any cover for them personally – but that’s the wrong way to look at it.

Lenders mortgage insurance provides a clear and undeniable benefit: it enables you to buy your own home quicker. Yes, it protects the lender rather than borrower, but without it you would have to wait longer (until you’ve saved up a larger deposit) to move into the home of your choice. With LMI, your deposit can be as little as 5% but without it, you’re looking at 20% or more. For many of today’s young, first-time home buyers, that kind of money can be a big ask.

Paying for LMI can mean getting the keys to your desired property sooner, which also means you’ve got a head start on building up the equity in your new home. On the other hand, waiting until you’ve saved up 20% of the property value for a deposit can work out well too, especially if the market cooperates with steady or falling house prices and you’re not in too big of a hurry to buy.

Understanding how home loans work and what LMI is all about will give you the edge as a first time home buyer.

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