Understanding Lender’s Mortgage Insurance and how you can avoid it
So you’ve decided to buy a house. Congratulations! No doubt you have been building up a deposit for that dream home for some time. As a standard rule of thumb, saving a 20% deposit on the house’s total value will allow a borrower to avoid paying Lender’s Mortgage Insurance (LMI).
What is Lender’s Mortgage Insurance?
In short, LMI is a one-off cost, paid by you – the borrower, to protect your lender in the event that you cannot meet your mortgage repayments. LMI should not be mistaken for Mortgage Protection Insurance, which covers your mortgage in the event of accident or death. Instead, LMI effectively means you are buying insurance that protects your lender (i.e. your bank) should you default on your loan.
If this seems unfair to you, consider the scenario where LMI does not exist.
Without LMI, lenders would restrict their mortgage lending to only those borrowers who have the capacity to save up to 20% or more of the total cost price of a property. For example, only borrowers with a $60,000 deposit or more could purchase a $300,000 home. In reality, saving $60,000 for a moderately priced home is beyond the capability of many first home buyers in Australia and as a result, most buyers would never achieve their dream of owning their own home.
The benefit of LMI is that it gives those borrowers, who may have a good financial history but struggle to save the prerequisite 20% deposit, the ability to buy a house sooner by borrowing up to 95% of the total value of the property.
Note: if you are a borrower seeking to refinance or purchase a second home, you will still have to purchase LMI if your home has less than 20% equity. In addition, LMI is not transferrable between lenders, so unless you have the equity, it’s likely you’ll be slugged with LMI a second time, even if you paid it when you first purchased the place.
How much does Lender’s Mortgage Insurance cost?
Putting an exact dollar figure on LMI really depends on your circumstances but it is not uncommon for the total insurance cost to run into the tens of thousands of dollars – in addition to the purchase price of the home. How much you pay in LMI depends on whether you’re a first home buyer or an existing home owner (first timers are usually considered a higher risk), as well as the type of property you are buying. For example, studio apartments and homes on acreages are usually considered a higher risk of default and thus normally require you to pay more LMI.
How can I avoid paying Lender’s Mortgage Insurance?
Most lenders waive LMI if you have more than 20% of the deposit saved for the loan. This is the norm, but it is by no means the rule and some lenders require a 25% or even a 30% deposit for them to waive LMI, depending on your financial situation.
That said, if you don’t have a 20% deposit in your bank account, there is another way to avoid LMI. A guarantor, such as a parent, can support your financial investment by allowing the equity on their property to be used as additional security for your home loan.
If you wish to purchase a $300,000 property but only have $15,000 as a deposit, your Loan to Value Ratio (LVR) is 95%, which means you will have to pay LMI. However, if a guarantor is willing to provide a guarantee for the additional 15% of the home loan using their own property as security, the LVR will reduce, placing you below the LMI threshold, leaving you with nothing to pay.
Bear in mind that the guarantor is not protected in any way from you defaulting on your loan. If you fail to make your repayments, you could not only lose your house, your parents could also lose theirs. For this reason, think long and hard before you take on the responsibility of either being a guarantor or using a guarantor on your home loan.
Author: Fiona Hamann
“Fiona Hamann is the senior PR manager at Aussie. She is passionate about all facets of communications including PR, writing, editing, website content, new media, crisis and issues management and branding in the finance industry – home loans, personal loans, credit cards, and insurance.”