Lenders Mortgage Insurance (LMI) is a type of insurance that covers a lender’s financial risk in case a borrower defaults on their mortgage repayments. It’s usually required when a borrower applies for a home loan with less than a full deposit.
Generally, the smaller the size of the deposit, the higher the cost of the LMI. The amount of LMI payable also depends on the size of the loan, and can often run into tens of thousands of dollars. You can use an online LMI calculator to get a fair estimate of how much extra you’ll need to shell out in LMI fees for a low deposit home loan.
How does LMI work?
Let’s assume you default on your home loan, and there’s still $550,000 owing to the lender. After repeated reminders, you fail to make the repayments, and the lender eventually sells the property to make good its losses. However, the lender only receives $500,000 in sale proceeds, leaving a shortfall of $50,000.
Normally, the lender can attach your personal assets to recover this shortfall. However, when you pay LMI, the lender can claim the shortfall from the insurer instead of coming after your assets.
Homeowners often confuse LMI with mortgage protection insurance, which is a different product altogether. While LMI only protects the lender in the case of default, mortgage protection insurance is designed to help with your repayments if you become seriously ill or meet with an accident (as laid down in the insurance policy).
Is it worth paying for Lenders Mortgage Insurance?
Most lenders require you to pay at least 20 per cent of the property’s price upfront as a deposit. However, saving a full deposit is no mean feat. Recent data indicates first home buyers take about eight years to save a deposit for a home in Sydney and a little less than seven years for a house in Melbourne. The “steep deposit burden” restricts many first home buyers from entering the market unless they are able to get support from their parents in the form of cash or a home loan guarantee. Alternately, first home buyers can consider paying for LMI to qualify for a home loan with less than a 20 per cent deposit.
Overall, LMI might prove to be a useful tool if you wish to enter the property market sooner without having to save a full deposit. This could be the case if you think you’re in a property market where prices are likely to hike faster than you save. Or, you’ve come across a rare deal on your dream home that’s too good to miss, and it’s going to remain a profitable deal despite the extra LMI fee.
On the flip side, the cost of LMI can run into several thousands of dollars and add to your debt. If you’re already struggling to save a deposit, you might find it difficult to foot the LMI payment upfront. Some lenders may allow you to roll the LMI into your loan, but you’ll then be charged interest on the additional amount, along with the rest of your loan, resulting in higher monthly repayments.
It’s also worth noting that LMI premiums are usually not refundable. While you may be able to transfer your loan to another property using the mortgage porting feature, you generally cannot transfer your LMI to another lender. This means you could be required to pay LMI again while refinancing if you borrow more than 80 per cent of the property’s price.
The answer to the question of whether it’s worth paying for LMI depends on your personal goals and circumstances. For instance, you may find paying LMI worthwhile if it gets you into a volatile property market sooner. On the other hand, you might find it practical to wait until you have an adequate deposit to save on LMI costs and potentially qualify for a better rate on your home loan. It could help to discuss your options with a mortgage broker to select the right course of action for you.
How can I avoid paying LMI costs?
Paying for LMI can help you purchase your home sooner, but it can also add thousands to your home loan costs. One of the simplest ways to avoid paying for LMI is to save up a 20 per cent deposit for your purchase. Even if you can’t meet the 20 per cent goal, it’s worth saving as much as you can to reduce your potential LMI costs.
Another option that first home buyers may consider is a guarantor home loan. If you can get a parent or other close relative to guarantee your mortgage with their own property, you could avoid paying for LMI despite having low deposit or even no deposit in some cases.
However, taking out a guarantor home loan places more responsibility on your shoulders. If you default on your mortgage repayments, your guarantor will be responsible for making the payments. If both you and your guarantor fail to meet the home loan repayments, the lender may sell your house, followed by the guarantor’s property, to pay for any shortfall. Therefore, it’s important for all the parties to be aware of the risks before signing up for this option.
Depending on the state in which you’re buying, you may be able to take advantage of state and federal grants to beef up your deposit. For instance, most states and territories offer the First Home Owner’s Grant (FHOG) to help first home buyers get into their homes sooner. You can check your eligibility for FHOG on your state’s website.
The federal government’s First Home Loan Deposit Scheme allows eligible Australians to buy their first home with just a five per cent deposit and no LMI. Single parents with dependent children can purchase a home with only 2 per cent deposit under the Family Home Guarantee. However, both the schemes have a range of eligibility criteria to fulfil, and only a limited number of spaces are made available in each financial year.
You may also check with your broker if you’re eligible for an LMI waiver. Certain professionals like doctors, lawyers and accountants are often considered low-risk by lenders. If you belong to any of these professions, you might be eligible for a professional discount that lets you borrow up to 90 per cent of the property’s value without paying for LMI.
