Lenders Mortgage Insurance protects your lender if you default on your home loan, but could mean that you access finance sooner
Lenders Mortgage Insurance (LMI) is an upfront charge you will pay if you borrow over 80% of your property's purchase price or value when buying a home or investment property.
Because LMI allows many borrowers to purchase a home with as little as a 5% deposit, it's not just a fee but also a tool. Read on to find out what it is, how it works, ways to avoid LMI, and answers to other questions you might have.
Bridget Sakr, Chief Commercial Officer at Genworth talks LMI
Lenders Mortgage Insurance (LMI) is how your lender protects itself in case you can’t repay your mortgage. You will only be required to pay an LMI premium if your loan is considered high risk -- if you’re taking out a large loan, more than 80% of the value of the property, or you don't have the full financials to prove your income and employment history.
Typically you will pay LMI on your home loan if you are borrowing more than 80% of the property value on a standard loan, or more than 60% of the property value on a low doc loan. You can pay LMI either as one-off lump sum at the establishment of the loan, or it can be capitalised onto the loan repayments. This means it’s added to the principal of your loan, and attracts an interest charge.
There are two major LMI insurers in Australia: Genworth and QBE. Some larger banks and mortgage brands will also sometimes self-insure. These include the Commonwealth Bank, ANZ and RAMS. Sometimes lenders will self-insure some borrowers and use an LMI insurer for other borrowers.
Compare home loans with 90-95% LVR
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The amount you pay for lenders mortgage insurance depends on various factors:
- Loan size. A larger loan incurs higher risk and thus higher LMI costs.
- Deposit size and property value. The size of your deposit relative to the value of the property helps determine how much LMI you have to pay (or whether you need to pay it at all). As a general rule the smaller your deposit and the higher the property value, the more insurance you'll pay.
- Loan type. Investment loans and owner occupier loans may lead to different LMI costs.
- Insurer. LMI costs differ by insurer. Note that the borrower can't choose their insurer: the lender does.
Example LMI costs
Genworth is one of the biggest lenders mortgage insurers in Australia. Their LMI estimate calculator can provide a rough idea of your LMI costs. The following quotes are for first home buyers with 30 year loan terms and are estimates only.
|Property value||Deposit size||Estimated LMI cost|
As the examples above show, LMI can add thousands of dollars to the cost of buying a home. With many struggling to scrape together enough funds for a 20% deposit, first-time buyers could end up having to pay more than they realise.
In the examples calculated above, if you bought a $1,000,000 home with a 5% deposit of $50,000 you could end up paying almost as much in lenders mortgage insurance premiums.
There are ways to avoid LMI, or at least minimise your costs. There are a few things borrowers can do - some more obvious than others. Some simple ways to avoid paying LMI include:
- Keep your loan to value ratio below 80%
Your loan to value ratio (LVR) is the amount you have borrowed in relation to what your property is actually worth. If this calculation results in a number less than 80%, you usually don't have to pay LMI. However keep in mind that to get your LVR below 80% you'll need to provide a larger deposit to allow you to borrow less.
Sometimes it's worth taking that extra bit of time to save a decent sized deposit, and sometimes, as explained below, it's not. Not just because you'll avoid LMI, but because a property is an investment, and you will need to consider a range of other factors other than the LMI premium.
- Know the premiums on your loan amount
LMI premiums on loans over $300,000 cost significantly more than those charged on loans less than $300,000. If you were looking to buy two investment properties for which you needed a $300,000 loan for each at an LVR of 95%, common sense would say to take out a loan for $600,000.
However, the premiums calculated on two $300,000 loans may be less than the LMI premium on a $600,000 loan. According to the Genworth LMI estimator, if you had an LVR of 95% on a $600,000 loan for up to 30 years, you could be paying a LMI premium of over $28,600.
- Split your investment loans to save on LMI
Using the above example of two separate $300,000 loans with a LVR of 95% each, the LMI premium is calculated on a lower rate for each loan, with a combined LMI premium of approximately $16,016. That's a saving of about $12,584, which more than makes up for the doubling up of application fees from two loans.
- Take out a family guarantee
A family guarantee or family pledge is when one of your family members guarantees part of your loan with their own property. They can usually nominate how much to pledge, and this is then added to your deposit amount. If you haven't saved enough to avoid paying LMI, a family guarantee can get you over the line with an acceptable LVR.
Jessica and Morris want to purchase their first home. The home they're looking at costs $500,000. They have $75,000 saved already, meaning the LVR of their loan is 85%, and may attract LMI.
If they receive a family guarantee from one of their family members for $25,000, this will mean their deposit is now $100,000 and their LVR is 80%, eliminating the need for them to pay LMI.
Remember family guarantees will differ depending on the lender, so be sure to consult with your lender to find out what's available to you.
- Look at LMI alternatives being offered by lenders themselves
Some lenders have their own LMI departments. Institutions like Westpac handle LMI for St.George for instance, while others outsource to companies like QBE Insurance and Genworth LMI.
According to Bridget Sakr, CFO of Genworth, "LMI as a financial product has been designed so it's seamless from the consumer's perspective." Borrowers don't have much of a say in this part of the loan application process – so, choosing an LMI insurer isn't going to have much of an effect on the end result. But there are alternatives to LMI offered by some lenders. ING, for instance, offers an alternative called a Reduced Equity Fee (REF).
An REF is usually cheaper than the price of regular LMI. Again though, this may depend on the lender and what specific scheme they have, so be sure to check with prospective lenders to see if they have an alternative LMI scheme. These alternative schemes can also sometimes be quicker than arranging an LMI, as your application is handled in-house.
Important Facts about LMI:
Let's take a look at the important facts about LMI:
It's there to protect the lender, not you: LMI is not provided by the lender. It generally comes from a 3rd party and is there to protect the financial interest of your lender. It doesn't cover your home loan repayments, so if you want protection in the event that you're unable to work you'll need to purchase a separate policy such as mortgage protection.
How much you pay for LMI is based on the amount you borrow: Your LMI premium is a percentage of the amount you borrow, but it's also calculated on a tiered basis depending on your loan amount. For example, the larger your loan, the larger the percentage of LMI you'll have to repay. Ideally you want a large deposit so your loan to value ratio is lower. That way you're less likely to trigger a LMI threshold.
You can pay your LMI costs upfront, or you can capitalise it, which means you fold the cost into the principal of your loan. In other words, you can borrow your LMI costs along with your loan and pay it all off over time.
Here's an example. Say you were to borrow $150,000 and your LMI premium is around $1,400. You would only receive $148,600, as part of the balance will go towards paying the premium. By capitalising the LMI premium onto the loan, you’re going to get $151,400 allowing you to use the full $150,000 you applied for. But note that because you're now borrowing more this can affect your borrowing amount. In other words, by capitalising your LMI costs you could be paying off less of your home loan at first.
Is it worth paying LMI or should I avoid it at all costs?
While the majority of advice out there may suggest avoiding LMI, sometimes paying the premium could be the better option. There are circumstances where you may have found the home of your dreams for a bargain, and you need a loan sooner rather than later: LMI allows you to do this.
Find out how much LMI will cost you and weigh this up against the cost of saving up for a greater deposit. The added expense of LMI may be outweighed by the equity you would've built up in your home by buying your home sooner. While you can never predict this entirely, if you're expecting the value of your property to rise, then getting your foot in the door earlier can be the wiser option even with the added cost of lenders mortgage insurance.
Given how fast some properties have risen in value over the last few years, paying the extra cost of LMI could be far more cost effective. If you keep waiting to save up a 20% deposit to buy a property that keeps rising in value you may never get there.
Dan the savings man
Dan is in the market for his first property. He has $30,000 in savings and wants to buy a $300,000 property. His savings of $30,000 are only 10% of the value of the property, so if he purchases the property now he'll more than likely have to pay an LMI premium.
If he purchased the property now, he'd have to take out a loan with an LVR of 90%. According to the Genworth LMI calculator, Dan would pay an estimated LMI premium of $4,077.00.
If Dan saves another $30,000 he'll have a 20% deposit and won't need to pay LMI. But how long will that take him? If property prices rise, he'll need to save even more than $60,000 to avoid LMI. Buying sooner could mean building up equity and making more in the long run.
*This is a hypothetical example only. Consult a professional before making any decisions, and find out if you should pay LMI or wait until you've saved enough.
Your lender may not announce the fact that you could be entitled to a lender’s mortgage insurance (LMI) refund but you should be aware of your right to a refund. If you repay your mortgage in full within one to two years since loan settlement, you could be entitled to an LMI refund.
Are LMI refunds available?
LMI refunds may be offered by some lenders, depending on the policy of their insurance provider. If your home loan was settled before 2012, and you repay your loan within the first one or two years, then it’s worth enquiring with your lender to see if you’re eligible.
How much is the refund?
The amount of the LMI refund varies depending on the insurance provider. The mortgage insurer calculates and repays the LMI refund.
Generally you can expect a refund of around 40-50% of the initial premium that you paid, but this will be determined on a case-by-case basis.
What criteria do I need to satisfy?
To qualify for an LMI refund, you will generally need to meet the following conditions:
- The loan must not have been in default, arrears or had any late payments throughout the term.
- The loan must have been repaid in full less than two years from the loan settlement date.
- The refund amount must be more than $500.
Keep in mind that the lender may have their own guidelines regarding the criteria you need to meet for a LMI premium refund.
Generally, the lender must notify the LMI provider (such as QBE, Genworth or the Commonwealth Bank Low Deposit Premium) that a refund is due within 30 days of the loan being discharged.
How do I apply for a refund?
To request a refund, contact your lender and tell them that you’d like to apply for an LMI refund. They will then notify you of the process and the next steps required. You may need to put forward a written request.
How long does it take?
An LMI refund can take between 3-6 months depending on the procedure of your lender and the lender’s LMI provider.
Your lender will be very helpful and eager to tell you about the benefits of LMI. Remember it's there for their benefit, not yours.
The biggest, (and most important) piece of advice we can give about LMI is to remember it does not protect your repayments if you can't afford them. You'll need to arrange your own income/repayment insurance just in case something unexpected goes wrong!