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. In some cases, this can also be charged on smaller amounts of as low as 60% of the purchase price for some low doc and credit impaired borrowers.
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 principle of your loan, and attracts an interest charge.
There are two major LMI insurers in Australia, including 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.
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A high LVR means a high LMI premium
As LMI is meant to protect the lender, it is applied to home loans that are considered a risk. In general, this level of risk is directly related to the loan to value ratio (LVR) but it can also be determined by the strength of the applicant. As a rule of thumb, any loan with an LVR in excess of 80% will need to be insured in case of borrower default, no matter the financial position of the applicant. Since LMI premiums are generally calculated as a percentage of the amount being borrowed, an LMI calculator can be used to estimate the approximate cost of this insurance policy.
It is advisable that you do your research because an LMI premium can have a massive jump in price even if your LVR is only increasing slightly. For example an LVR of 90% will incur a much higher LMI premium than an LVR of 89%.
How is the LMI premium calculated?
The insurers who underwrite use an LMI Rate Chart or a Premium Table to calculate the LMI premium. The premium is calculated based on the size of your loan in relation to value of the property you’re purchasing -- this is known as the loan to value ratio (LVR). Some insurers like Genworth have an LMI estimator, which shows how much you could be paying.
Example LMI Calculation
For example, if you are borrowing $255,000 to buy a property valued at $300,000 you are borrowing 85% of the property value, so your loan to value ratio (LVR) is 85%. Even though you are borrowing more than 80% of the value of the property, the loan is small and the LVR is low, so you will probably pay the minimum LMI premium. But if you were to borrow $950,000 on a property valued at $1 million then your LVR is 95% and the LMI premium is likely to be high.
In the 12 months leading up to July 2013, QBE LMI and Genworth Financial, the two dominant mortgage insurance insurers in Australia, both have increased their premiums. As a result, borrowers who fail to meet the 20% deposit requirement will be forced to pay higher LMI premiums.
These changes were introduced despite the fact that Australia has one of the lowest mortgage default rates in the world. According to a report issued by Fitch, the percentage of mortgage delinquency increased from 1.57% in December 2011 to 1.6% in the first quarter of the following year.
LMI can add thousands of dollars to the cost of buying a home, with these changes being a particular issue for first-home buyers. 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.
Calculations made with the Genworth LMI premium estimator reveal the difference having a 20% deposit can make to your premiums. Say you’re a first-home buyer looking to purchase a property valued at $500,000 and taking out a loan term of up to 30 years. If you have a 15% deposit, your premium is calculated at $4,420 (excluding stamp duty). If you only have a 10% deposit, however, that premium rises to $7,920.
Can I pay LMI upfront?
Yes, you can pay LMI upfront.
What if I don’t have the cash to pay the LMI premium?
Most lenders allow LMI capitalisation. This refers to the practice of adding the LMI premium onto the principle of the loan. Say you were to borrow $150,000 and your premium is around $1,400. You would only receive $148,600, as part of the balance will go towards paying the LMI 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.
Do home loans have to be approved by the mortgage insurer?
You might be surprised, but applications for risky home loans also have to be approved by mortgage insurers. This is because the LMI insurer is taking the risk from the lender. You will find that mortgage insurers are just as conservative, if not more so, than lenders. They require the borrower to have a credit history with no blemishes, a savings record and stable employment.
The lender will take care of submitting the documentation to the mortgage insurer, but cannot guarantee your application will be approved if you do not meet the criteria.
Was your home loan rejected because of LMI?
There aren't many LMI insurers in Australia, which means if your application for a home loan is rejected because of an LMI insurer's criteria, you might want to apply for another home loan with a lender who self-insures or uses a different LMI insurer.
Mortgage brokers are a good source of expert advice in this regard. They'll know which lenders to approach for your situation, and don't usually charge you anything, as they're paid by your bank through commissions.
Why do you have to pay LMI?
Before 1965, lenders would only approve loans for up to 80% of the property value to reduce their risk; however, this made it very hard for some buyers to secure a home loan, especially first home buyers. As a result LMI was introduced to remove the risk from the lender if you are unable to repay your loan. The insurer takes on the risk of loss if you default and will sell the security (the property) to recoup any costs if the borrower is unable to make their repayments. This system allows borrowers to get a loan with a 5% or 10% deposit rather than needing the full 20%.
It is important to remember that you are paying LMI to protect the lender, not yourself. The LMI insurance policy does not cover any damage to the property, and is different to loan protection insurance which protects you if you can’t make your repayments because of illness, injury or unemployment.
Who calculates LMI?
While there are a number of LMI insurers in Australia, the choice of company is not up to you, but determined by your lender. Home loan usually lenders have commercial agreements with one to two insurers, and some have their own in-house insurance departments.
Some lenders have forged a close relationship with their insurer, and this can give the lender the ability to approve loans on behalf of their insurer. This is called Open Policy, or Delegated Underwriting Authority and if you use this type of lender, you can have your loan approved, where it may have been declined by the LMI insurer.
Australian Mortgage Insurers
Mortgage insurers have a reputation for being extremely conservative, due to the high risk associated with loans. Currently, the two major LMI insurer in Australia are Genworth Financial and QBE, and make up 80% of the market. Banks handing their own LMI make up for the other 20%.
Genworth Financial operates in over 25 countries and have 15 millions customers worldwide. QBE LMI (Private Mortgage Insurance) PMI was part of an American owned mortgage insurer but has dominated the Australia, New Zealand and Asian insurance market.Back to top
How to avoid paying LMI
If you don't have a deposit, LMI is the price you'll pay for a loan. But there are some ways to lessen the cost.
When it comes to getting a home loan your payments and deposit aren't the only costs you need to take into consideration. You might run into all sorts of other charges like arrangement fees, legal fees, and of course, LMI. But there's good news. If you know how LMI is calculated, you can take steps to minimise the costs of LMI, or avoid it altogether.
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.
How to avoid paying the maximum LMI premium possible
In some cases it's possible to avoid paying LMI altogether. There are a few things you 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.
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 Direct, for instance, offer 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.
LMI VS REF example
A borrower looking to buy a $400,000 home with a 10% deposit of $40,000 would be looking at an LMI fee of approximately $7056. If that borrower was instead eligible to take out a REF, they'd pay approximately $4200. These are just estimates, and they can change; however it's important to know that alternative schemes like REFs can come with additional application criteria which may not normally apply to LMI.
Should LMI be avoided?
While the majority of advice out there may suggest avoiding LMI, sometimes paying the premium isn't as much of a necessary evil as you'd think. 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 will allow 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.
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 $3,294. But if he waited until he'd saved up a 20% deposit, he'd end up buying a property three years later, providing his $60,000 deposit was still large enough.
The argument goes that if Dan paid LMI and got his home sooner, he would have already built up equity in his property, as he would've been putting his money into his mortgage rather than his rent and savings accounts. This could put him on the road to owning a second and third property in the future.
As always, 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. Don't forget 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!Back to top
Frequently asked questions:
Why is LMI required?
LMI covers the lender, not the borrower, in the case that you don't make any of the repayments onto the home loan.
Do I benefit from LMI?
While LMI is designed to protect the lender, you will also be able to receive some benefits from the insurance. Before LMI was introduced you would have had to find 20% of the home value for a deposit.
However, now that LMI is available you're able to borrow up to 95% of the home value in some cases. Furthermore, LMI protects the lender if they lose money. If lenders were not getting money back for borrowers who defaulted on their mortgages then they could raise the interest rates of loans to compensate.
Who pays the LMI premium?
LMI will have to be paid by you if you are looking to buy a home without having a 20% deposit for standard loans.
What is the cost of LMI and how is it paid?
The premium is due at the beginning of the loan, which is payable upfront by the borrower, or added onto the principal of their loan - otherwise known as LMI capitalisation. If you choose to add it onto your principal, then the lenders will pay the premium first and you'll pay it back with interest.
Are the insurers reputable?
All LMI providers operate within strict government guidelines. All lenders will have to operate within these guidelines
How is LMI arranged?
LMI is not automatically applied for and must be organised with the application to the loan. The application documents for LMI that will have to be paid when you are refinancing will be organised by the lender. They will give you the documents and answer any questions that you may have about the insurance. If you pass all the requirements for LMI then you'll be issued with it.