When purchasing a property, if you do not have a minimum deposit of 20% of the purchase price, plus costs, you will likely incur Lender’s Mortgage Insurance (LMI). A lender will likely deem that your application contains greater risk to them if your Loan to Value Ratio (LVR) is more than 80%, and in this instance LMI will be charged.
The actual reason, other than not having enough deposit, for LMI being charged is often unknown. Simply speaking, Lender’s Mortgage Insurance protects your chosen lender in the event that you are unable to meet your mortgage repayments, the loan is foreclosed on and the lender loses money in the sale of your property.
Example – Loan to Bank Z is $500,000. Property sold under Mortgagee in Possession and after costs the bank receives $450,000 to pay out their loan. This leaves a shortfall of $50,000 and is where the insurer then comes in to provide coverage to the lender. It is then likely the insurer will pursue you the customer for any loss.
A common misconception is that it is insurance to protect you the borrower, however as highlighted above it is in fact the opposite and it is there to cover the banks interest.
Although LMI can be expensive, it’s an alternative way for you to enter the property market without having to save a larger sum to put towards a deposit, allowing you to purchase a property sooner. Fortunately, LMI is often added to your home loan, meaning you won’t be required to pay a lump sum upfront and can pay it off over the term of the loan.
A positive way to look at LMI is, as mentioned, is that it is your key to entering the property market earlier. An example of this is – you are looking to buy a property now for $500,000. You have a deposit of $50,000 and because it is less than 20%, LMI of $10,000 will be charged. To avoid this LMI fee you would need to save an additional $50,000. The question you need to ask yourself here is, “How long will it take me to save another $50,000?”. This then needs to be compared with the question “How long will it take the property I am looking at to increase in value $10,000?” If the property will increase by the cost of LMI faster than it will take you to save the extra $50,000 then the cost of LMI may end up being irrelevant as you would either miss out on the property or find that it costs more to purchase when you finally have the 20% saved.
If you do not have 20% deposit, then an alternative to Lender’s Mortgage Insurance would be to have a parent or family member offer their property as security through a family guarantee arrangement. There is strict criteria around this however it will enable you to avoid paying LMI as the equity in your guarantors property is used to secure your loan meaning it is structured so that your LVR is less than 80% - meaning no LMI. In addition to not paying LMI in this instance, which is normally a really sizeable saving, it is likely you will obtain lower interest rates also.
If you are a Medical Professional, you also may be able to avoid paying LMI with less than a 20% deposit. In most cases, lenders with a “Medico LMI Waiver” policy will tend to accept a minimum deposit of 10% + costs and in one special occasion there is a lender currently offering this to a minimum of 5% as long as special conditions are met.
The rate at which LMI is charged also varies from bank to bank, depending on a number of factors. Because of this and the different policies that the banks and insurers have, it is imperative that you work with a broker when obtaining finance for your home as your broker will be able to review the different policies and costs and ensure you are placed with the right lender to suit you.
Although LMI is an extra cost, it is a fee that a lot of borrowers pay to enable them to enter the property market or maximise their leveraging. It is something to be aware of and not afraid of as it could mean you can buy your next home sooner than you think.
Owner / Multiple Franchise Manager