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What is lender’s mortgage insurance?
Lender’s mortgage insurance (LMI) protects your lender when you take out a home loan where there’s an increased risk associated with your loan.
If you have a deposit of at least 20% of a property’s purchase price, generally you won’t be asked to pay this type of insurance*.
However, if a lender (such as a bank or financial institution) agrees to lend you more than 80% of the property’s value, there is a higher risk that—if the loan isn’t repaid as agreed—the lender may lose money.
That’s where LMI comes in. It’s important to understand it’s there to protect the lender, not the borrower, unlike some other types of insurance.
When do I need lender’s mortgage insurance?
As a property buyer, you may need LMI if your deposit is less than 20% of what the lender thinks your property is worth, sometimes called a bank or lender-assessed valuation. Note that your lender’s value of the property may not be the same as the purchase price you pay, or what you believe your existing home is worth.
What is the cost of LMI?
It is a one-off cost that will generally come down to the lender you choose, the loan amount, the size of the deposit you have, and the value of the property that you’re looking to buy or refinance.
LMI is calculated as a percentage of the loan amount. It varies depending on a number of factors including your loan to value ratio and how much you plan to borrow.
Alternatively, you may be able to add the LMI fee to your total home loan amount. However, it’s important to note that this will increase what you owe, what you will have to pay back in interest, as well as your minimum monthly loan repayments.
Can I avoid paying LMI?
If you can’t save up a 20% deposit, you could avoid the costs of LMI if someone acts as a guarantor for your home loan.
A guarantor is responsible for paying back the entire loan if the borrower can't. The property to be purchased or refinanced acts as partial security for the lender, and the equity in a guarantor’s property provides additional security. Guarantors generally need to be immediate family members, though each provider may have its own terms and conditions.
Risks of having a guarantor
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The guarantor’s property and credit rating could be put at risk if the borrower doesn’t repay the loan.
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By tying up the equity in their own home, the guarantor may not be able to use it if they need to.
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Relationships could be affected if things don’t go to plan.
It’s important that your potential guarantor understands what’s involved, and seeks legal and financial advice before acting as a third party on your loan.
Don’t confuse LMI with mortgage protection insurance. Mortgage protection insurance is designed to help you meet your mortgage repayments if you become seriously ill or incapacitated and can’t work.
What happens if I refinance?
When you refinance, your original mortgage ends and you make a new loan arrangement with another lender. You can’t transfer an LMI policy.
That means you’ll need to pay for a new LMI policy if you still have a low amount of equity in the property (you’re borrowing more than 80% of the property’s value).
The pros and cons of LMI
Pros
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If you can meet the normal lending criteria but can’t make it to the 20% deposit threshold, you may still get into the property market with a smaller amount, as long as you can meet the mortgage repayments.
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You won’t need a guarantor to supply additional security.
Cons
Is it worth paying LMI or should I save more?
Home buyers often debate whether it’s better to hold off on house hunting until they’ve saved up a bigger deposit or bite the bullet and pay LMI.
Every buyer’s situation is different and may depend for instance on how likely they are to be able to find a bigger deposit and whether they think house prices will rise or fall.
For example, if you’re looking to get a place of your own to start a family in a city with rising house prices, you might find it hard to get close to a 20% deposit.
You may be keen to get into the property market as soon as you can, because you think prices will accelerate faster than your ability to raise a larger deposit.
If that is the case, you might opt to pay LMI because you believe the chance of capital gain in a rising market outweighs the cost of LMI.
Alternatively, you might feel more comfortable waiting until you have a deposit big enough to pay less, or no LMI.
The answer depends on your personal circumstances, as well as factors such as loan amount, house market volatility and interest rates.
Have a word with your mortgage broker or talk to us about what’s right for you.
©AWM Services Pty Ltd.
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