What is Lenders Mortgage Insurance?
Acquiring a home requires a rather large sum of money that most people are simply unable to accumulate. This is where mortgages come into play. You take out a mortgage against the house you’re purchasing and pay the lender back over some time — generally 20-30 years. But lenders aren’t simply going to lend you the money based on goodwill, they need some sort of guarantee that they can recover funds if you were to default on the loan — this is where a deposit enters the game. But what dollar figure is a good enough deposit? Banks typically require 20% of the property value to be covered in order to lend you money — and this is where lenders mortgage insurance (LMI) is added to the mix.
What is Lenders Mortgage Insurance and how does it work?
LMI is an insurance policy designed to protect the lender from financial loss in the case that the borrower is unable to meet their home loan repayments. The risk to lenders is that the borrower could default on their loan, resulting in the property needing to be sold to recover the value of the mortgage, and then the proceeds from the sale of the property not being sufficient to cover the unpaid value of the mortgage, leaving the lender out-of-pocket. LMI is a way for the lender to mitigate this risk. If this scenario was to occur, they’d simply claim the insurance policy to cover their losses.
LMI is expensive for borrowers, however, it means that lenders are able to lend larger amounts and approve more home loans due to the risk minimisation LMI provides them. It’s also helpful if you’re unable to save the required 20% deposit.
How much does LMI cost?
The exact cost of LMI varies greatly depending on your risk assessment which looks at circumstances such as the size of your deposit, the value of the property, and your employment status, to name a few. Generally speaking, the cost of LMI falls between $3,000 and $30,000.
The cost of LMI can be paid upfront or added to the home loan to be paid off (the latter option attracts additional interest charges due to the capital increase of the loan). The policies are non-transferable meaning they can’t be moved to a different lender if you choose to refinance.
When is LMI necessary?
LMI is generally required when your loan-to-value ratio (LVR) is more than 80%. In other words, when the deposit is less than 20% of the value of the property.
From January 1st 2020 the government is offering a First Home Loan Deposit Scheme to 10,000 eligible applicants. Under the scheme, approved applicants with a deposit of as little as 5% will be able to secure a loan without needing to pay for LMI. The government will guarantee the amount required to reach the 20% deposit.
To be eligible for the grant you must be a first home buyer with an annual taxable income of less than $125,000 as a single person, or $200,000 as a couple. To find out more about the scheme visit nhfic.gov.au.
Whilst LMI is genuinely useful in the sense that it allows banks to take on more risk and lend more money to people with insufficient deposits, it comes at a price to the borrower. If you’re thinking about purchasing a house it might be a wise decision to weigh up whether paying for LMI is the best choice for you.