Lenders Mortgage Insurance (LMI) is a one off insurance premium you must pay to the lender if your total loan amount is greater than 80% of the value[1] of the property that secures the home loan.
You will need to allow for LMI if your deposit is less than 20% of the value of the property.
Who does it protect?
Lenders’ mortgage insurance protects the lender (not you, the borrower) should you default on your home loan and the property is foreclosed upon.
LMI covers the lender against any shortfall when the property is sold.
How is LMI calculated?
The amount of LMI you must pay is predicated on a “rate for risk” basis, so it will vary based on your:
- Total loan amount, and
- Loan to value ratio (LVR) – the proportion of your loan amount in comparison to the property value (e.g. if you have a 10% deposit, your LVR will be 90%).
In broad terms, the higher your loan amount and LVR, the greater the perceived risk is to the lender and insurer. The higher the risk, the higher the LMI premium you will need to pay.
How is LMI paid?
LMI is charged to you as a one-off premium, payable upon loan settlement.
Depending on the type of loan and product, some lenders allow you to include the LMI premium in your loan amount. This would enable you to maximise funds you can contribute toward your deposit (as you won’t need to pay the LMI premium out of your savings).
How can I avoid (or minimise) LMI?
The best way to avoid having to pay LMI is to provide a 20% deposit. Loans at 80% LVR or under do not require LMI to be paid.
If you do have to pay mortgage insurance, a useful tip is to try to limit your LVR to 90% or less. This is because there is a significant increase in LMI premiums once your LVR exceeds 90%.
For example, the LMI premium [2] for a $500,000 loan on a property with a $556,000 property value (89.93% LVR) is approx. $9,145. To purchase the same property with a loan amount of $528,000 (94.96% LVR), the LMI premium [2] is approx. $24,440.
LMI rates and conditions can vary across lenders so contact me to discuss your specific requirements in more detail.
What role does LMI play?
Lenders’ mortgage insurance can feel pretty onerous. After all, why would you want to pay for insurance that protects the lender, not you.
It may help to remember that lenders’ mortgage insurance can give you the opportunity to purchase a home much earlier, or to buy a higher-value home with a smaller deposit.
For some clients, LMI can provide increased flexibility for them to purchase property at a time of their choosing.
Notes:
1. The property value is based on either the purchase price, or value determined by a lender authorised valuation, whichever is the lower. (As part of the loan application process, the lender will usually undertake an independent valuation of the property.)↩
2. Figures calculated for Lenders’ Mortgage Insurance premium are general and based on Genworth LMI calculator as at 18 March 2014 for a NSW property.↩