What is Lenders Mortgage Insurance (LMI)?
If you are looking to purchase a home and have a deposit of less than 20%, you can expect to pay a premium toward something called LMI.
LMI, or Lender’s Mortgage Insurance exists to protect the lender if a client defaults on a home loan that is considered to be ‘high risk’. It’s an insurance policy that covers the lender if the borrower defaults on the loan and the property sale results in a shortfall of funds. Lenders can claim on the LMI policy in such a case.
An important distinction to make is that LMI is not there to cover you (or your guarantor), it simply exists to protect your credit provider in the event that you cannot pay back your loan.
The important thing to recognize is that not everyone pays for LMI. Usually, LMI is only required when the borrower is taking out a loan for 80% or more of the value of the property (meaning they do not have the ‘traditional’ 20% deposit). This percentage is otherwise known as the Loan-to-Valuation-Ratio or LVR, and in most cases, if your LVR is over 80%, you will most likely be required to pay for Lenders Mortgage Insurance.
How can I avoid paying LMI?
Save 20% Deposit
A higher deposit means a smaller loan amount. If you have 20% deposit or more the bank will view you as being less of a risk.
First Home Loan Deposit Scheme
The government is helping first home buyers enter the property market through the First Home Loan Deposit Scheme.
The scheme enables eligible first home buyers to buy a house with as little as 5% deposit. Under the scheme, borrowers will not have to pay Lenders Mortgage Insurance (LMI).
Security Guarantor Loan
A Security Guarantor Loan is when someone, usually a close relative such as a parent, uses the equity in their property to help you secure yours.
Having a guarantor on your loan often means that you won’t need a deposit at all. Guarantor Loans may also help you to avoid paying Lenders Mortgage Insurance.
This option isn’t right for everyone however, as there are some risks involved for the Guarantor. It’s smart to speak to a professional before applying for this type of loan.
Lenders view some professions as being less risky and may waive LMI fees. For example, medical professionals and doctors usually enjoy waived LMI fees because lenders perceive their professions as being stable and with a high income.
Some lenders offer special loan benefits to professionals earning $150,000+ a year because they consider them to be ‘low risk’ borrowers.
When is it better to pay Lenders Mortgage Insurance?
The second path can be described as more pragmatic and may apply to a larger sector of the public. Here you are spending money to make money. The cost of paying the LMI can often be added to the principle of the mortgage and therefore allow you to enter the market quicker.
If you are like most people, saving money is hard. Even if you are disciplined, life can get in the way and unexpected costs can arise that put a dent in your savings. Those of you with kids know exactly what I am referring to.
If your saving power is low and your rent is high, then you will probably benefit from paying the LMI and taking that step to ownership sooner.
Hot Tip, At the moment interest rates, are at a record low and most experts consider the current market to be a buyer’s market. This means that there is generally more supply than demand and it’s exactly in this scenario when great deals could present themselves. If you are not quite ready with your deposit, maybe an LMI could help you get over the line!
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 a financial adviser about what’s right for you.