One of the key dilemmas confronting potential homebuyers is the issue of a deposit. Waiting until you have saved a deposit will save you money by avoiding the requirement to take out mortgage insurance.
However, the downside of going down the deposit path is the waiting issue. People are rarely good at waiting.
Moreover, waiting could mean missing out on that dream property and a foothold on the homeownership ladder while continuing to live with your parents, adorable though they may be or continuing to pay rent, money that could be paying down a mortgage.
With home prices presently tumbling in Sydney and Melbourne, it is timely to look at Lenders Mortgage Insurance, what it offers and its costs.
LMI: An Increasingly Accepted Risk
Data from the Reserve Bank of Australia suggests the less patient are voting with their money. Around one-quarter of all Australian housing loans are covered by LMI.
Another consideration is that many of these borrowers are under the mistaken belief that Lenders Mortgage Insurance covers them rather than their lender.
So just what is Lenders Mortgage Insurance all about?
Introducing Lenders Mortgage Insurance
Lenders Mortgage Insurance is an insurance policy covering the mortgage lender against a potential loss in the event the borrower cannot keep paying their loan repayments and default on their home loan.
If a borrower subsequently defaults on their mortgage, their lender can recover the outstanding debt by repossessing the property, which the home loan is secured against.
However, if the property’s value has dropped, the lender can incur a loss on the loan. LMI covers the lender against this risk.
With this risk mitigated through the Lenders Mortgage Insurer, lenders are subsequently more willing to approve loans at a higher loan-to-value ratio of up to a maximum of 95 per cent of the property’s value or sale price, whichever is lower.
When LMI was launched in Australia in 1965 it created more opportunities for homebuyers to be approved for a home loan while also encouraging lenders to charge customers lower interest rates.
While LMI may cover the lender, the borrower, rather than the lender pays for it. So what does it take to avoid having to resort to LMI?
Lenders Mortgage Insurance Deposit Requirements
Generally, lenders exempt borrowers from Lenders Mortgage Insurance if their deposit exceeds 20 per cent or an 80 per cent Loan to Value Ratio.
Most lenders view borrowers with deposits of over 20 per cent as being less likely to default on their loan. Similarly, a 20 per cent deposit is considered a sufficient buffer to protect lenders from a fall in property values ensuring lenders have a significant chance to recover the outstanding amount in the event a borrower defaults on their loan.
In some instances, lenders may demand a larger deposit. Some lenders view specific suburbs as having higher potential default rates or as being at risk of experiencing a large fall in property values. Hence, the lender may demand a larger deposit of up to 30 per cent for the borrower to be exempted from LMI.
Other Strategies To Avoid LMI
There are other strategies borrowers can employ to be exempted from paying LMI. These include:
- Having a guarantor: Many lenders will waive LMI on the loan regardless of the size of the deposit if the borrower is supported by a acceptable guarantor typically a parent with equity in their home or cash savings to cover 20% of the borrower purchase cost that legally accepts responsibility for the mortgage repayments in the event the borrower is unable to make them.
- Working in a profession: Professions considered to be highly paid and comparatively stable such as solicitors, judges, barristers, doctors, dentists, optometrists, actuaries, CFOs, auditors can sometimes borrow up to 90 per cent LVR without having to pay LMI. Such professions can include:
Alternatively, a combination of factors such as demonstrating a perfect credit history, proposing a small loan amount for a purchase in a low-risk suburb can also see LMI waived on a home loan proposal.
Paying Lenders Mortgage Insurance
LMI premiums are often paid as an upfront one-off lump sum fee at settlement when the loan is drawn down.
Alternatively, LMI can be capitalised and added to the loan amount and gradually paid off as part of the regular mortgage repayments. However, the repayment model accrues interest on the premium increasing your LMI costs over the long term.
Refunding Lenders Mortgage Insurance Premiums
When you change lenders or purchase a new property, it’s unlikely you will have your premiums refunded. You may even face the situation of having to pay LMI premiums once more if your LVR is still above 80 per cent.
However, where the loan is terminated early in the first two years of the loan, you may be eligible for a partial refund of LMI premiums. Your ability to qualify for an LMI refund is also dependent on the lender’s LMI policy provider and meeting their refund criteria. So, check with your lender to see if you’re eligible for a refund.
Typical LMI Cost
The cost of LMI premiums generally varies according to the size of the loan and the LVR, as shown below. LMI premiums can also be affected by what type of borrower you are. For example, first-time borrowers often pay a higher LMI premium than existing borrowers, even for the same LVR and loan size.
|Estimated Lenders Mortgage Insurance (LMI) Premiums|
|Est. Property Value||95% LVR||90% LVR||85% LVR|
Source: Genworth LMI premium estimator. Prices including GST but excluding stamp duty. Calculated on a 30-year loan term
In a real estate market where property values appear to be falling such as is the case in Sydney and Melbourne presently, the case for paying LMI as a cost of entry to lock in potential capital gains on a rising market is less compelling. Similarly, many borrowers also see LMI as wasted money given it protects the lender rather than the borrower. At the end of the day though, if you have a strong emotional connection to your dream house and you don’t think you’ll have the opportunity to buy it in the near future, LMI could be the solution to closing the deal.