How does Lenders Mortgage Insurance (LMI) work?

In Australia, we've seen house prices rise* at a record rate. This is great for those who have an investment property or want to sell their home, but this rise is making it a lot harder for first-time buyers trying to get into the property market. 

Because of these high prices home deposits are growing and saving for them feels unreachable. If you're in this tricky position, paying Lenders Mortgage Insurance (LMI) may help you achieve your goal faster. 

This article will answer our most frequently asked questions about LMI to give you a better understanding if it is the right option for you!

We will cover:

What is Lenders Mortgage Insurance?

Lenders Mortgage Insurance, also often abbreviated to LMI is a one-off fee that you will need to pay if you borrow more than 80% of your home’s value (in other words, if you have a small house deposit). It’s there to protect the lender in case you are unable to repay your loan.

In basic terms:

• lenders protect themselves with Lenders Mortgage Insurance, and
• borrowers can buy a home sooner with a smaller deposit.

Who needs to pay LMI: usually LMI is required if you borrow more than 80% of your home’s value. For example, if you take out a loan for $400,000 but only have a $20,000 deposit you can expect to pay LMI.

However, there may be other instances where you’ll be expected to pay LMI. So, it’s always important to talk to your lender – they can tell you everything you need to know about your LMI, especially how much it will cost.

How do you pay for LMI: In most cases, the LMI fee is bundled in with your home loan amount which your lender will sort out for you. However, if you wish lenders may let you pay it upfront, as a lump-sum.

Why LMI can be a good option for you

Saving a 20% deposit for the current house prices is not easy for most people, then after years of savings that deposit might not be enough due to rising property prices.

However, with LMI, your deposit can be as little as a 10% (or 5% in some cases), helping you secure a home loan sooner. LMI is usually added to your home loan and won't need to be paid in a lump-sum up front. 

Then once you're in the market the increase in property prices will benefit you!

Is LMI the same as Mortgage Protection Insurance?

No, Lenders Mortgage Insurance is there to protect the lender in case you default on your home loan.

Mortgage Protection Insurance protects you, the borrower, in the event you can’t make your repayments due to unforeseen circumstances like unemployment, injury, illness or death. If that’s something you’re interested in, then it might be worth talking to a trusted insurance professional/provider.

How much does LMI cost?

The amount you pay for Lenders Mortgage Insurance will depend on several factors including the size of your loan, your deposit amount, loan type, purchasing purpose and source of deposit.

Loan size: The more you borrow, the more risk your lender takes on, and this is reflected in the cost of your LMI. For example, if you’re buying a property valued at $800,000 and a loan-to-value ratio (LVR) of 85% you can expect to pay over $12,000 more in LMI compared to a property valued at $300,000 with a similar LVR.

Deposit amount: The smaller the deposit, the higher the cost of LMI as there’s more risk for the lender. For example, if you’re purchasing a 30-year home loan for a property worth $400,000. A 10% deposit ($40,000) would result in an LMI of roughly $13,000. With a 15% deposit ($60,000), the LMI will be significantly lower at approximately $7,000.

Type of loan: The type of loan you apply for can also change your LMI. For example, most lenders will charge LMI on a low-documentation home loan, when a borrower takes out more than 60% of the property’s value. Whereas, with a traditional home loan, LMI is only usually charged if a borrower takes out more than 80% of the property’s value. Fixed and variable rate home loans don’t attract different LMI amounts if everything else is the same.

Purchasing purpose: If you’re purchasing an investment property, lenders may charge you more for LMI than they would if you were planning to live in the property. This is due to associated investment risks such as tenants not paying rent, refusing to move out or maliciously damaging property.

Source of deposit: Lenders tend to be more trusting if you have used ‘genuine savings’ for your house deposit as it demonstrates your commitment to making loan repayments after you buy a property. If you use a gift or a lump-sum from selling something instead, it’s considered riskier for the lender and you’re likely to pay more for LMI.

For these reasons, an accurate cost of your LMI can’t be given until you’ve chosen a property and lender. That’s why it’s always important to only use LMI calculator estimates as a rough guide.

How does LMI affect my home loan?

Regardless of whether you pay for LMI upfront or bundle it into your home loan, it still increases the overall cost of your home loan. That’s why it’s always a good idea to chat with your lender about what you will actually end up paying and what you will need to budget for, to determine whether it’s the best option for you.

Approval process: Having to pay LMI may also make the home loan approval process more complex and lengthier, as the insurance company that provides LMI to your lender may also need to approve your application. However, your lender should be able to tell you the likelihood of LMI approval, and roughly how long the application will take.

How can I avoid paying LMI?

There are a few ways you can avoid paying LMI, including:

Saving for a bigger deposit: If you can save the minimum deposit for your property (which is usually 20%), then you will more than likely avoid paying LMI.

Getting a guarantor: A family guarantee could help you avoid paying LMI and get you into the property market sooner by leveraging equity from a family member’s property. Your guarantor would accept legal responsibility for your monthly repayments if you can’t pay, which reduces the risk for lenders. However, there’s both pros and cons to this option, so it’s always a good idea for the potential guarantor to chat with a financial advisor before making a decision as it may affect their future borrowing capacity and ability to sell their own property.

Getting a cash gift: Cash gifts from family members can be used towards your deposit and might help to lower your LMI premium or avoid paying LMI all together.

A cash gift may not always guarantee a loan by itself. Some lenders may also want to see that you can support yourself and make repayments. They may look for a steady income as well as evidence of a good savings history. In most cases, you will need a minimum of 5% genuine savings (your own savings) to qualify for a home loan.

Lenders can accept a cash gift as genuine savings, however there will be a wait involved. You will usually have to leave the cash sitting in your bank account for three to six months. This is to show you can save the gifted funds and are not reckless with money.

Additionally, most lenders will want to make sure the cash is a gift and not a loan. So, you will more than likely need to present a letter to your lender that states that the giver has no stake in the property, no commercial interest, and no expectation of repayment.

Applying for the First Home Owner Grant (FHOG): If you’re a first-time homebuyer in South Australia, you may be eligible for the FHOG. Through the FHOG, you can apply for a grant of up to $15,000 on the purchase or construction of a new residential home in South Australia. This could help lower the cost of your LMI or eliminate it altogether if you have additional savings.

Find out if you’re eligible for the grant by visiting the SA Government website.

Disclosing your occupation: If you work in certain industries such as healthcare or law, you may be able to borrow up to 90% of a property’s value without incurring LMI– 10% more than people in other professions (if you have proof of employment and income). Your lender will be able to tell you whether you’re eligible for a LMI exemption or discount based on your profession.

Stamp duty and taxes on LMI

If you’re buying a home, both stamp duty and GST are usually included in the quoted price of your LMI. If you’re buying an investment property, a portion of your stamp duty and GST can be claimed as tax-deductible.

LMI alternatives

If you’re borrowing more than 80% of your home’s value, most lenders will ask you to pay LMI to protect themselves in case you’re unable to repay your loan.

However, some lenders have created their own LMI alternative in the way of a once off ‘risk fee’, also sometimes known as Reduced Equity Fee (REF) or Low Deposit Premium (LDP).

Although a risk fee (compared to LMI) is usually cheaper, it can often come with a higher interest rate or limited protection, which could end up costing you more in the long run.

Before you jump into a home loan, make sure you speak with your lender about LMI or risk fee costs, so you can determine what’s the best option for you.

Exemptions to LMI

A lender may waive LMI if you meet specific criteria such as:

• your LVR is only slightly over 80%,
• you work in an industry (medical, law) that qualifies for a LVR of up to 90%, or
• you’re using an internal LMI substitute – like a risk fee – with your lender.

Your lender will be able to tell you whether you’re eligible for a LMI exemption or discount.

Do I need to pay LMI when refinancing or purchasing my next home?

If you have a variable rate home loan, you may decide to refinance your loan if you find a better deal somewhere. Unfortunately, LMI can’t be transferred to a different lender, so if you’re refinancing more than 80% of the property value, you’re likely to have to pay LMI again.

The same goes if you’re looking to buy your next home, you may have to pay LMI again to get a new home loan.

The best way to know for sure what you will have to pay, is to chat to your lender. They will tell you everything you need to know about your LMI costs.

Can I get a refund on LMI?

No, LMI is non-refundable or transferable. However, some lenders may give you a partial refund if you repay the loan within two years.

Check in with your lender, to find out their rules around LMI reimbursements.

What happens if I default on my loan?

If you happen to default on your home loan, your lender could repossess your property and sell it to cover the unpaid balance. If the money from the sale isn’t enough to cover all the losses, a lender can make an LMI claim with their insurer. Afterall, that’s what LMI is for.

However, keep in mind that you will still be responsible for any outstanding debt. Your lender will usually create a new repayment agreement with new terms.

How to calculate LMI

Many LMI calculators are available online. Here are some example estimates:

These are estimates only, taken from the Credit Union SA Buying and Selling Costs Calculator. All estimates are for first home buyers, owner occupied with 30 year loan, LMI costs are slightly higher for non-first home buyers.

To get the exact cost of your LMI, make sure you speak with your lender.

In conclusion

There’s no denying that Lenders Mortgage Insurance can help first home buyers get into a home quicker with a smaller deposit, however it’s an additional fee that can be avoided by saving a bigger deposit, getting a guarantor, or having family chip in.

Whether you should pay for LMI or wait until you have a bigger deposit will depend on your individual circumstances. Ultimately your decision should be based on your own financial needs and goals.

Our lending experts can help talk through your options.

So why not make an appointment with one of our friendly Mobile Lending Managers, like Susan, who can come to your home or office at a time that suits you. Call us on 13 8777 or visit us at 400 King William Street, Adelaide between 8am – 5pm weekdays or 8am – 2pm Saturdays. We’re here to help!

*source: Real Estate