Lenders Mortgage Insurance Explained
It’s no secret that getting into the property market is tough for first home buyers, especially in our major cities. So how much do first home buyers need to crack open the door?
A deposit of 20% of the purchase price is the general requirement to take out a home loan. Considering the median unit price in Sydney has been approximately $740,000 in 2018, buyers will need to save a deposit of $148,000, which could take years for many people to reach.
Luckily, Lenders Mortgage Insurance (often referred to as LMI) can be a secret weapon for many first home buyers.
So just how many buyers use this secret weapon? According to the Reserve Bank of Australia, an estimated 1/4 of Australian mortgages are covered by lenders mortgage insurance, and with the cost of housing, particularly in our capital cities, that number is likely to grow.
If you’ve never heard of lenders mortgage insurance you may think it’s just another cost on the expensive road to homeownership, but unlike the fees and the taxes, lenders mortgage insurance can be a very useful tool that could save you money in the long term.
What is Lenders Mortgage Insurance and what does it do?
Lenders mortgage insurance protects the lender in case the borrower defaults on their loan and cannot make repayments. If a borrower defaults and they have taken out lenders mortgage insurance, then the lenders mortgage insurance provider will pay the deficit to the lender in order to cover the loss.
Generally, lenders will allow you to borrow 80% of the property purchase price, but with lenders mortgage insurance you can borrow up to 95% of the property value. In some cases, lenders mortgage insurance has allowed buyers to enter the market with no deposit at all. It’s a big risk for lenders to provide credit to a buyer with less than a 20% deposit, but lenders mortgage insurance minimises that risk for lenders.
Lenders mortgage insurance should not be confused with mortgage protection insurance, which covers the borrower if they are unable to meet their loan repayments. This type of insurance will cover a borrower in situations where they lose their job or get sick and therefore cannot make repayments.
How much is mortgage insurance?
The cost of lenders mortgage insurance will depend upon your individual circumstances and the size of your deposit. As a general rule, a smaller deposit will mean a more expensive lenders mortgage insurance premium.
Lenders mortgage insurance is generally arranged by the lender and costs vary significantly. They are dependant upon the type of loan, the lender, and the lenders mortgage insurance provider. It is therefore important to look around and consider the cost of lenders mortgage insurance when finding a loan provider. Choosing a better rate on your lenders mortgage insurance could save you thousands of dollars.
How is lenders mortgage insurance calculated?
Lenders mortgage insurance is calculated as a percentage of the loan amount, where a number of factors are considered. Lenders mortgage insurance is primarily based on the size of your deposit and the property you are purchasing. This is called the loan to value ratio or LVR.
For example, a buyer purchasing a $500,000 property with a deposit of $35,000 will have a loan to value ratio of 93%. This buyer’s LMI premium will be more expensive than a buyer with a $70,000 deposit and a loan to value ratio of 86%. The cost of lenders mortgage insurance commonly increases or decreases in increments according to the loan to value ratio.
Because lenders mortgage insurance is based on the level of risk, a lender will also consider a borrower assessment when calculating lenders mortgage insurance. A borrower assessment will look at factors like your employment status, credit history, income and expenses to determine your risk as a borrower.
Is lenders mortgage insurance a one-off payment?
Lenders mortgage insurance is a one-off payment that is due at the time of settlement, along with other lender fees and government charges. It can be paid as a lump sum, or added to the total loan amount to be paid off over the life of the loan through a small increase in repayments. The second scenario is the case for most buyers taking out lenders mortgage insurance.
Do I need mortgage insurance?
There are a few reasons you may need mortgage insurance.
Do you want to get into the property market sooner? If the answer is yes, then you will likely need lenders mortgage insurance. Home buyers should consider the time it would take them to save a 20% deposit and the rate at which property prices will likely increase. Given the current rates of inflation, buyers could be better off purchasing their home with lenders mortgage insurance than waiting to save a 20% deposit. The financial rewards of entering the property market sooner could outweigh the initial costs of lenders mortgage insurance.
What if I have a poor credit history or no credit history?
Lenders are very wary of borrowers who have a mark on their credit history, or buyers with little credit history. Often these buyers will find it difficult to be approved for a home loan. If you’re looking to purchase a property with a poor credit history, paying lenders mortgage insurance can help to minimise the risk for the lender. With the backing of lenders mortgage insurance, a lender will be more willing to approve your loan, despite your credit history.
What if I don’t have secure employment or proof of income?
If you don’t have secure employment or consistent proof of income, a lender may be hesitant to approve your loan. Again, lenders mortgage insurance can help to minimise the risk in these situations and a borrower may be approved with the added security that lender mortgage insurance provides.
Lenders mortgage insurance, combined with a good credit history and stable income allow lenders to offer borrowers lower interest rates and better home loan deals than if LMI wasn’t an option.
How can I avoid paying lenders mortgage insurance?
While lenders mortgage insurance is undoubtedly a helpful tool for those wishing to get into the property market sooner, it’s still potentially an added expense.
The obvious way to avoid paying lenders mortgage insurance is to save a 20% deposit. As previously discussed, it’s ‘easier said than done’, but if you are in a position to, you could ask your parents to loan you some money, move back in with your parents, take on a second job and/or dramatically cutting spending. You may also reconsider where you are looking to purchase a property and choose a more affordable area instead. All these steps may help you reach a 20% deposit sooner.
In some limited circumstances, a lender will waive the need for lenders mortgage insurance even when a buyer is looking to borrow more than 80% of the property’s purchase price. A lender will only offer this to very low-risk borrowers who can demonstrate a secure full-time job, good credit history, evidence of financial savings and stable housing history.
A family pledge loan can also help you avoid lenders mortgage insurance. This type of loan allows you to borrow more than 80% of the property purchase price (even up to 110% to help you cover the cost of purchasing a property), using a percentage of the value of the residential real estate of an immediate family member.
The family member becomes the guarantor, and as a result, you do not require lenders mortgage insurance. This can be risky because your family member or guarantor will be liable if you can not meet loan repayments. On the other hand, it can be a great way to enter the market and the guarantor will no longer be liable when the property’s value increases or the loan decreases back to an LVR of 80%.
How should you organise lenders mortgage insurance?
Lenders mortgage insurance is usually arranged through your lender who will either self-insure or use a preferred insurance provider. It is best to discuss your own situation with your lending officer, remembering that there is always room for negotiation.
Just like you should shop around for the best home loan, you can shop around for the best lenders mortgage insurance. Lenders mortgage insurance premiums vary and could make a big difference to the total cost of your loan.
At Mortgage House, we are no stranger to the homeowner’s journey. It’s a long (but rewarding) one.
Getting into the property market doesn’t have to be hard. At Mortgage House we’re committed to seeing our customers achieve their goals. For the best home loan products, support and advice contact us today!