5 things you need to know about LMI
While researching home loans, you may have come across the term Lenders Mortgage Insurance or LMI, but what does it mean?
LMI is an insurance that lenders take out in order to be able to lend to borrowers who have a smaller deposit (ie generally when the amount you are lending is more than 80% of the value of the property). Smaller deposits equal more risk for lenders, so LMI allows Australians to borrow more without lenders shouldering the risk on their own.
What does LMI do?
Lenders mortgage insurance (LMI) is a one off insurance premium that has a purpose of protecting the lender in the event that you default on your mortgage.
Even though the property itself acts as security for the loan, once default costs and interest are added, the sale of the property may not be enough to cover the outstanding debt should you default. This is particularly true if property prices have stagnated and when sold the property achieves for less than what it was originally purchased or valued at.
LMI reduces the risk for lenders that they will lose out due to a shortfall and allows them to lend more money to more borrowers.
When do you need to pay it?
Lenders usually take out this insurance when they are lending more than 80% of the value of the property. The premium is usually passed onto the borrower and added to the loan amount.
Did you know? The higher the percentage of the loan compared to the value of the property the more you will have to pay for LMI.
How much will it cost?
The amount of LMI you pay will depend on how much you are borrowing, deposit size as well as the lender, but it will most likely equate to several thousands of dollars.
For example, if you buy a property worth $400,000 and borrow $360,000 (90% of the property’s value), you will pay $7,056.00 excluding stamp duty, according to the Genworth LMI estimator.
What happens if I refinance?
Lenders Mortgage Insurance is lender specific and not portable. This means that if you decide to refinance to a different home loan and you are still borrowing above 80% of the property’s value, you will most likely have to pay LMI again. This can often outweigh the benefits of refinancing to a lower rate home loan.
So, before you refinance, speak with your lender about the LMI costs and calculate whether it is worth the move or not.
How can you avoid it?
Unlike costs like stamp duty, it is possible to avoid paying lenders mortgage insurance.
- You will need to save a deposit of 20% or more of the purchase price. This will also include extra funds for other costs like stamp duty and solicitors fees.
You can get help using a gift or guarantor.
- Gift. A money gift can be a way to help add to your deposit and avoid mortgage insurance. It is still good to have a solid savings history and lenders will want to see savings evidence if you are borrowing more than 85% of the value of the property. If you are close to 80% and if your parents are keen to help out, this may be a way to avoid it
Guarantor. This is done by someone (often parents) offering a property they own as additional security for your loan. Your loan will then be secured over the property you are purchasing and your parent’s property. The lender then has sufficient equity to lend at 80%, even though you don’t own this property. There are downsides to guarantees. These include:
- Making it difficult to use the equity themselves or sell the property
- If you default on your loan, their property could be at risk of being sold to fund the shortfall