Find out all you need to know about LMI, including how to avoid paying it!
Why Do Lenders Charge LMI?
Lender’s Mortgage Insurance, or LMI, is insurance that protects your lender, not you as the borrower. If you were to default on your mortgage, LMI would protect your lender from a financial loss.
If you borrow most of the purchase price – anything more than 80% - your lender could end up losing money in the case of a default. From legal expenses, to the potential to lose a lot of money on the sale of the property, there are many reasons why, loaning more than 80% of the purchase price would simply be too much of a risk for banks without the proper insurance.
This is why lenders charge LMI for loans with a high Loan to Value Ratio (LVR). Anything over 80% LVR is considered risky enough to require LMI. Charging Lender’s Mortgage Insurance is a way to reduce their risk so they can lend high LVR loans in the first place.
In fact, before Lender’s Mortgage Insurance was used, banks rarely would lend more than 80% of the purchase price for a home loan because of the risk involved. This made it a lot harder to enter the real estate market as many Australians couldn’t afford a 20% deposit. In 1965 the Housing Loans Insurance Corporation was established to help make homeownership more affordable. By creating mortgage insurance, lenders could offer better rates and accept smaller deposits because they no longer had to worry about the substantial risk of a buyer defaulting on their mortgage. LMI protects them from financial losses.
What Does LMI Cover?
Lender’s Mortgage Insurance covers loss of principal and any unpaid interest. It also will protect the lender against any losses incurred during the process of selling the property such as legal fees, repairs, and marketing costs.
What’s the Difference Between LMI and Mortgage Protection Insurance?
LMI protects the lender and is mandatory for high LVR loans. Mortgage protection insurance, on the other hand, protects the borrower and isn’t related to your home loan application – it’s something you take out on your own, for yourself.
So, why would someone take out mortgage protection insurance and pay LMI?
Some people decide to pay for mortgage protection insurance to give themselves the peace of mind that comes from knowing they’ll be able to keep paying their mortgage if something unexpected happens. This type of insurance is only relevant under specific circumstances like a serious illness that stops you from working and earning an income, or if you suddenly become unemployed. It also helps your spouse or other beneficiaries pay off your home loan if you pass away.
Whether you want to get mortgage protection insurance or not depends on your and your family’s unique financial situation and is something you can discuss with an independent financial advisor. Just keep in mind, paying Lender’s Mortgage Insurance doesn’t offer you protection from a default. It only reduces risk for your lender.
Do I Have to Pay LMI?
For a typical home loan, you will have to pay LMI if you borrow more than 80% of the purchase price. This is true no matter which Australian lender you apply with.
With some types of loans, such as a low doc loan, you’ll be expected to pay LMI if you are borrowing more than 60% or 70% of the purchase price.
This is something to think about when you are planning to apply for a loan. LMI can easily end up costing several thousand dollars. You’ll want to be financially ready so you aren’t surprised when the lender calculates your LMI premium.
There are ways to avoid paying Lender’s Mortgage Insurance. With a large enough deposit – 20% or more of the purchase price – you can avoid paying LMI. You may also be able to avoid it by using a guarantor loan.
Who Arranges Lender’s Mortgage Insurance?
When you apply for your home loan, you don’t have to worry about setting up LMI. Your lender has a contract with their own LMI provider and then includes the premium in your loan.
It’s worth checking which LMI provider your lender uses. Each insurer uses unique criteria for approving a borrower. If your loan application is denied because you weren’t approved for Lender’s Mortgage Insurance, you may want to apply with a lender who uses a different LMI provider. This may increase your chances of getting your loan approved the next time around.
If you aren’t sure if you have to pay LMI of you’ve been denied by one LMI provider, call us today (07) 3146 5732 to talk to one of our mortgage specialists or contact us online.
When Does the Lender Charge the LMI Fee?
Usually, you pay the entire LMI premium when your loan is settled as a one-time fee. The lender will include the premium amount in your loan and then deduct it before the loan is advanced.
For example, if you borrow $290k, the purchase price is $320k, and your LMI premium is $2,600, you’ll only receive $287,400 when the loan is advanced. This means you’ll need to come up with the extra $2,600 for the deposit because the purchase price is still $320k!
Some lenders will let you capitalise the LMI premium so you don’t have to save a larger deposit. With LMI capitalisation, the bank lends you the LMI premium in addition to your original loan. Then, you would pay slightly higher monthly repayment amounts to pay back the Lender’s Mortgage Insurance premium over time rather than paying it as a lump-sum upfront. In our example of the $290k loan, you’d borrow $292,600 with LMI capitalisation, which would include the $290k to buy the property and the $2,600 for LMI.
How Much Does LMI Cost?
Figuring out how much you’ll have to pay for LMI isn’t easy because lenders don’t list the premium rates of their LMI provider. What you can do, however, is estimate what your LMI premium may be using an LMI calculator.
Keep in mind, the cost of LMI will ultimately depend on several factors, including:
- Loan size
- Deposit amount
- Whether the loan is an investment loan or an owner-occupier loan
- Your employment status
- Your level of genuine savings
- Whether or not you are a first time homebuyer
- Mortgage term
- The insurer your lender uses
The two core factors that impact the premium price are the Loan to Value Ratio and the loan size. The higher the LVR, the higher your premium. The same goes for the loan size – a larger mortgage will come with a more expensive LMI premium.
To get an idea of how much LMI will cost, here is a look at a few examples using an LMI estimator from one of the major LMI providers in Australia. Looking at Genworth’s LMI premium estimator (January 2019):
- With a $400K property value and a $40k deposit, your LVR would be 90%. A first time buyer would pay $6,912 for LMI – or an additional $35 per month for LMI capitalisation on a 30-year loan.
- For the same $400k property, if you increased your deposit to $60k, which means you’d borrow 85% LVR, your premium would be $3,842, or $19.47 a month if your lender capitalised the premium.
- For a larger loan – even with the same 85% LVR – your LMI premium would go up. For example, to purchase a $750k property with a $112,500 deposit, your LMI premium would be $8,287.50 as a first time home buyer for a 30-year term. With LMI capitalisation, you’d pay an additional $42 per month on your mortgage.
How Is LMI Calculated?
To determine your LMI premium amount, lenders take a percentage of your loan amount. The specific percentage used is primarily based on the LVR and the loan size.
There may also be a reason to increase the percentage even further. Basically, if you could be considered to be a slightly riskier candidate than the standard borrower, your lender may use a premium loading. For example, some lenders will apply a 10% premium loading to the LMI calculation for self-employed borrowers. Typically, premium loadings are applied in these scenarios:
- You are self-employed
- You’re refinancing from a different bank
- You’re using an investment property to secure more than half of the property
- You don’t have genuine savings
- In some cases, geographic premium loadings apply
A premium loading can increase your premium significantly, making your mortgage even more expensive if you don’t have a large enough deposit to avoid paying Lender’s Mortgage Insurance in the first place. This is the case unless you apply with the right lender – there are some lenders who have agreements with their LMI providers which them not to include loadings.
Also, even though you can get a basic idea of what to expect when you use an LMI calculator, it’s important to keep in mind that the insurance providers themselves have different premium rates. That means your premium could vary by hundreds of dollars – or more – simply based on which LMI provider your lender works with.
If you have questions on how LMI may impact your loan, our mortgage specialists are happy to help. Call us on (07) 3146 5732 or contact us online today.
Can You Ask Your Lender to Use a Specific LMI Provider?
Borrowers can’t influence which LMI provider their lender uses. Lenders have agreements with the one or two mortgage insurers they work with, so they cannot decide to use a different insurer for an individual borrower.
The only control you have over your LMI premium is in the lender you apply with. By choosing a lender with lower premiums, you can help to keep the amount you pay in Lender’s Mortgage Insurance to a minimum.
Is It Smarter to Pay LMI or to Wait and Save a Larger Downpayment?
Saving enough for a 20% deposit can take years, which is why a lot of borrowers, especially first time home buyers who are anxious to transition from the rental market to the property market, choose to pay LMI. Another factor to consider is how much the housing market itself can change over the time it takes you to save for a deposit.
Imagine this scenario: It takes you six years to save $80k so you have a 20% deposit for a $400k home. What happens if property prices go up so much that homes in your preferred neighbourhood are now priced at $450k or more? You’d need to save another $10k in order to have a large enough deposit and avoid LMI.
Deciding if you should buy a home sooner rather than saving to avoid LMI depends on a lot of factors.
- How long would it take to save 20%? Is that enough time for housing prices to change significantly?
- Are property prices going up right now? If you’re already paying rent and prices are on the rise, it may be smarter to buy sooner rather than later.
- Are property prices going down or stagnant? In this case, you may end up with a lower LMI premium or be able to avoid it if you wait and save a larger deposit.
- Do you have someone who would be your guarantor? With a guarantor mortgage, you may be able to borrow as much as 105% of the purchase price without having to pay LMI.
Keep in mind, the lower your Loan to Value ratio, the lower your LMI premium would be anyway. If you have enough saved for a 15% deposit or more and the purchase price isn’t that high, your LMI premium could be reasonably low anyway.
To help you decide if you should apply now and pay LMI or wait until you have a 20% deposit, estimate how much your LMI payment may be. Then take a look at what direction local property prices are moving in and how long it would take you to save enough. It’s always helpful to talk to an independent financial professional like your financial advisor or accountant as well.
Applying for a Home Loan with LMI
There are numerous factors that impact how much your LMI premium will be. By choosing the right lender and taking a look at what you can do to change your expected Loan to Value Ratio, you may have a smaller premium to deal with. The less money that has to be devoted to mortgage insurance gives you more money to put toward paying down your mortgage!
If you are applying for a home loan and will have to pay Lender’s Mortgage Insurance, contact us to learn more about how LMI may impact your loan. Call (07) 3146 5732 or contact us online to speak with one of our Australian mortgage specialists.