Many home buyers in the recent past have realised their dream of property ownership without saving a large deposit by opting to pay Lenders Mortgage Insurance or LMI. LMI protects the lender in case you default on your home loan repayments. In general, if you are borrowing more than 80 percent of the property’s value or taking out a bad credit loan or a low-doc loan, your lender will require you to pay LMI premium, given the risk involved in the transaction.
While LMI can add a few thousand to your purchase cost, on the bright side, it enables you to buy a home with as low as 5 percent deposit. Here’s all you need to know about LMI.
What is LMI?
LMI can be defined as a tool that allows home buyers to purchase a property with less than 20 percent deposit by protecting lenders against payment defaults. The risk of lending is transferred from the banks to the insurer, facilitating high LVR loans for the borrowers.
LMI can be paid as lump sum or rolled into your loan amount, in which case it will also attract interest.
A report by Genworth states “the provision of LMI to lenders has contributed to comparatively high levels of Australian home ownership and residential mortgage loan accessibility, supporting the housing market in Australia.” Indeed, since its introduction in 1965, LMI has been an important part of the mortgage market in Australia, enabling many Australians to buy property without waiting to amass a large deposit.
Why am I required to pay LMI?
LMI is a one-off fee that is charged by the lender if you need to borrow more than 80% of the value of the property.
The concept was introduced in 1965 to facilitate home loans for borrowers with less than 20 percent deposit. In the case of borrower default, the insurer takes on the risk and makes good any loss after selling the property. Thus, borrowers can get approved for a home loan with as low as 5 percent deposit with LMI.
As home loans with loan to value ratio (LVR) of more than 80 percent are considered risky, LMI is naturally applied to such loans. Also, if you are a low-doc borrower or do not have a strong credit history, lenders might consider you a high-risk borrower and ask you to pay LMI on your home loan.
Top mortgage insurers in Australia
When taking out LMI, it is not you who choose the insurer but the lender, who will pass on your documentation to the mortgage insurer for approval. Genworth and QBE are the top mortgage insurers in Australia. Also, a few banks (such as Westpac) have their in-house branches handling LMI.
How is LMI premium calculated?
LMI premium is calculated as a percentage of the amount you borrow. It is calculated on a tiered basis, according to the amount of the loan, and several other factors such as the amount of deposit and your employment status.
As an example, a first home buyer buying a $500,000 property with 10 percent ($50,000) deposit will pay $8,640 as LMI premium on a loan term of 30 years. However, with 5 percent deposit ($25,000), this amount almost doubles up to $15,960.
You could estimate your LMI premium using one of the many online calculators (for example this one).
How is LMI payable?
The LMI premium is a one time cost that can be paid up front when the loan amount is advanced. Alternately, some lenders allow you to add the cost of LMI premium in your home loan, which means you don’t need to pay this amount up front, but your monthly repayments would increase a bit to cover the cost of the premium.
You might be eligible for a partial refund of the LMI premium if the loan is repaid within the first two years of its term. However, the policy varies between lenders, and it is recommended to speak to your bank to understand their arrangement better.
How can I avoid paying LMI?
LMI has become more of a necessary evil today. Indeed, it adds to your loan cost, but it also enables you to own your home sooner. Here are a few tips to minimise or completely avoid paying LMI:
Have a larger deposit – One of the simplest ways to avoid LMI is to have at least 20 percent deposit for your purchase. Apart from that, you need about 5 percent extra to meet other costs and charges. Considering an average house price of $650,000, this means you need a minimum amount of $130,000 to purchase a home without paying LMI. First Home Buyers might be eligible for State Grants that could ease the pressure to some extent. (Check your eligibility)
Get a guarantee – By requesting a family member to guarantee your home loan against their property, you could own a house with as low as 5% of the purchase price. A family guarantee loan remains an attractive option for young home buyers to break into the property market. However, be sure that you can afford the repayments in the future as your parent’s home might be at risk.
Know the LMI on your premium – LMI premium depends on the amount of the loan. It is calculated on a tiered basis. The insurance premium on a loan of $300,000 is much lesser in comparison to a larger amount. It may be worthwhile to confirm with your broker or lender if you are near to a less expensive tier and save up a little more deposit to save a lot on the premium.
Consult an expert – If you are a low-risk professional such as a doctor or a lawyer, individual banks will lend you up to 90 percent of the purchase price without charging LMI. There are also a few lenders out there who offer alternatives to LMI such as a Loan Provision Charge or a Reduced Equity Fee, which could turn out to be cheaper than LMI in particular cases. A broker could advise you on such a scenario, in addition to apprising you about the alternative schemes offered by lenders currently.
“LMI is only payable if the refinance or purchase exceeds 80% of the property value. In saying that, there are a couple of lenders that don’t charge LMI even up to 85%. Furthermore, depending on your profession, there are lenders who offer to lend at 90% LVR without having to pay lenders mortgage insurance,” explains Michael, a mortgage broker with HashChing.
A good broker can help you assess whether you need to pay LMI and also put you in touch with the right lender for your requirement, apart from facilitating the home loan process for you. Get in touch with an expert now.
Does LMI benefit me?
The Genworth Homebuyer Confidence Index, Edition 8, reveals, “High property prices are still the number one barrier to purchasing a home (33%), followed by the difficulty of saving for a deposit, which rose to 24% (from 20% in September 2015).”
|Linda decided to buy a home worth $500,000 but only had $50,000 saved to pay as deposit. With a steady job and decent income, she knew she could afford the repayments on the home loan, but could she borrow with just 10% deposit?
Contrary to popular advice, instead of waiting to save a larger deposit, Linda contacted a mortgage broker who advised her to go for a low deposit loan (90% of the property price) and pay a modest LMI premium. He informed Linda that she could add up the LMI amount to her home loan without worrying about paying it up front. Thanks to the savvy advice, Linda owns a unit in Melbourne today!
But what would have happened had Linda decided to wait up for 2-3 years to save another $50,000 for the deposit? The chances are property prices would have increased, and $100,000 would no longer have been enough for a 20% deposit. On the other hand, LMI enabled Linda to buy the home early and build in equity in her home by using her money to make repayments instead of paying monthly rent. In the next three years, she can buy another property using the equity in the home.
Just like Linda, there are a number of home buyers waiting to jump on the property bandwagon but are not able to save enough for a 20 percent home loan deposit, thanks to the rapidly increasing property prices in the country.
LMI is one such tool that allows you to purchase your dream home with as little as 5 percent of the purchase price, making home ownership much more achievable than ever before.
By purchasing your own home or an investment property sooner than later using LMI, you could build equity fast enough to offset the cost of the one time LMI premium that enabled you to buy the property in the first place. However, it is best to consult an expert before making a decision – whether you should wait until you have saved enough or pay LMI to buy your dream home now.
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By Vidhu Bajaj
HashChing Content Writer