Buying a house is a big investment. Saving for a deposit can take many years. Lenders mortgage insurance (LMI) is an option for those who want to get into the market sooner but don’t have the full 20 per cent deposit saved. LMI protects the lender in the event you default on your mortgage repayments.
Many aspects make up LMI, as well as key considerations to keep in mind when choosing whether to pay LMI or save for a larger deposit to avoid paying it.
What is lenders mortgage insurance?
Lenders mortgage insurance is a one-off, non-refundable, non-transferrable premium that’s added to your home loan. The amount you’ll need to pay depends on several factors including the size of your deposit and how much you’re borrowing.
When people see the word ‘insurance’, many assume this cost is protecting them. However, it’s quite the opposite. LMI protects the lender against any loss they may incur if you are unable to repay your loan. It does not protect you.
If you don’t have a 20 per cent deposit, you’ll need to pay LMI. While you won’t need to arrange this yourself, speaking with a mortgage broker will help you to understand what you’re paying and answer any questions you may have.
How does it work?
Because the property market is constantly changing, lenders view clients without a 20 per cent deposit as a higher risk.
If they were to lend more than 80 per cent of the value of the property and property prices dropped, the banks would be left with a liability. With clients paying LMI, the lender is protected in the event the borrower fails to meet their mortgage repayments, the bank has to sell the property and there is a shortfall between the property sale price and the outstanding mortgage. The lenders mortgage insurance payment then covers this shortfall.
For example, you default on your home loan and there’s still $600,000 owing. Your lender then sells the property to recover this amount, but they only recover $550,000 when the property sells. This would mean there is a shortfall of $50,000 which comes from your LMI payment.
How is it calculated?
The cost of LMI is based on how large your deposit is and how much you’re borrowing. This means that the cost is never a set amount, but rather unique to your financial situation. LMI is calculated as a percentage of the loan amount and will vary depending on your loan to value ratio (LVR). For this reason, you can pay up to thousands of dollars.
Some other factors that impact LMI include:
- Whether your property is owner-occupied or not – it is believed that you’re less likely to default on a loan if the property is also your residence
- If you are self-employed or paid as a PAYG employee
- Whether or not you have genuine savings
- Whether or not you’re applying for any government grants
- If you are a first home buyer or a second home buyer
Are there any exemptions or concessions?
Exemptions or concessions for LMI aren’t very common. However, there are a few. The Victorian government has introduced the Victorian Homebuyer Fund shared equity scheme. This government incentive helps first home buyers with a 5 per cent deposit to get into the market sooner. The government will contribute up to 25 per cent of the purchase price in exchange for an equivalent share in the property. This can reduce your mortgage and you won’t be required to pay LMI.
Some lenders also grant reduced or fully waived LMI costs for those in certain professions. This is because lenders view that if you work in a safe, secure, and high-paying industry, you’re more likely to be reliably employed for years to come.
These professions include:
- Lawyers and conveyancers
- Doctors and surgeons
- Financial planners
To be eligible for this, you usually need to meet an income threshold typically around $150,000 a year, depending on your industry, as well as be part of your industry’s peak body or authority e.g. Australian Medical Association.
How to avoid paying LMI
There are a few ways you can get around paying LMI – especially if you’re trying to break into the market sooner. These are:
Saving a larger deposit
One of the simplest ways to save on the cost of LMI is by saving more for a deposit. However, this can be a more time-consuming option. As the market is constantly changing, the 20 per cent goal you’re aiming for may change over time, too. When choosing between paying LMI or saving a larger deposit, it’s all about opportunity cost and weighing up your options.
To learn more, read our blog on LMI vs 20 per cent deposit and the opportunity cost.
Asking a parent to be your guarantor
A guarantor is looked upon favourably by lenders. They are a third party – typically a parent – who agrees to repay a loan if you can’t; this includes any additional fees, charges and interest. If your parent owns an asset with equity, they may be eligible to become a guarantor. They can be beneficial in supporting you to get into the market, but their financial future will be affected. If the borrower can’t pay the loan, the partial or full debt will fall onto the guarantor. This could then affect your ability to get a loan and impact your credit score.
Guarantors can be removed later, however, it’s important to discuss and understand the risks involved with a mortgage broker.
To learn more, read our blog on using a guarantor to purchase a home.
Applying for government grants
There are government grants available when it comes to buying a home. Depending on where you live and where you’re buying, some may be able to help reduce the costs of purchasing. The Victorian Homebuyer Fund shared equity scheme mentioned above aims to help first homeowners get into the market sooner. Other fees such as stamp duty are removed for purchases under $600,000 and greatly reduced for purchases between $600,000 and $750,000. Other states like New South Wales offer waived LMI to first home buyers who have a 5 per cent deposit, where the government then acts as a guarantor for the extra 15 per cent.
In Regional Victoria, the First Home Owner Grant is doubled so first homeowners may qualify for a grant of $20,000. While this isn’t eliminating LMI, it is supplying extra money for deposits for first-time buyers.
LMI is an unwanted cost many homebuyers encounter, however, it’s a necessary one to protect the lenders if you default on your repayment. LMI covers the shortfall in the event your house needs to be sold and is sold for less than what it was purchased for. If you’re looking to get into the market – whether it’s your first house or your next house – one of our team can talk you through how much you may need to pay. Reach out to us today.