Lenders mortgage insurance can cost quite a bit, but there are ways to avoid it.
Lenders Mortgage Insurance (or LMI) is a type of insurance to help protect lenders from people defaulting on their loans (or dying). In Australia, as a buyer you’ll need to pay for Lenders Mortgage Insurance if the amount you’ve saved as a down payment isn’t more than about 20% of the purchase price of the property you’re buying or building.
Risk is a very important factor for lenders – and the idea behind mortgage insurance is to protect lenders when they’re giving higher risk loans. Lenders Mortgage Insurance is what allows lenders to offer low deposit loans, where the amount borrowed is anywhere up to 95% of the purchase price (or beyond).
The amount of Lenders Mortgage Insurance you’ll need to pay will depend, among other things, on the size of the deposit you have to begin with.
When is Lenders Mortgage Insurance needed?
It’ll depend on your lender and your specific circumstances, but as a rule of thumb you’ll normally need to pay Lenders Mortgage Insurance when the deposit you’ve saved is less than 20% of the value of the property you’re buying. From the bank’s perspective, that would mean that the loan would be for more than 80% of the value of the property – this figure’s referred to as the Loan to Value Ratio (or LVR).
As an example, if the property you want is $500,000, you may need mortgage insurance if your deposit is less than $100,000. Most first home buyers will need to pay Lenders Mortgage Insurance.
Some people who are self employed or who have a hard time proving their income through the normal means may also need to apply for a low doc loan (short for ‘low documentation’). Where this is the case, Lenders Mortgage Insurance is likely to be necessary for a mortgage even if the loan’s for as little as 60% of the value of the property being bought.
How is Lenders Mortgage Insurance paid?
Lenders Mortgage Insurance is normally paid up front when you’re arranging the loan, often as a part of the amount that’s drawn for your mortgage. So for example, if the mortgage is for $400,000 and the insurance premium for the LMI is $5000, your mortgage would become for $395,000 (with the extra going towards your premium).
You can choose to add the LMI premium to the value of your loan too (e.g. bump it up to $405,000) – this is called LMI capitalisation, or ‘LMI capping’ for short.
Lenders Mortgage Insurance can either be in place for a set period of time, or until a certain loan to value to ratio (LVR) is reached – for example, 60% of the market value of the property.
How to avoid paying Lenders Mortgage Insurance
The first and most obvious way to avoid having to pay Lenders Mortgage Insurance is to have a nice big deposit to begin with. You’ll probably need a deposit that’s at least 20% of the value of the property you want to buy if you want to avoid paying LMI this way.
Your second option is to find someone who’s willing to act as a guarantor. Your parents, for example, can agree to guarantee your loan. In most cases the guarantor will only be liable for a part of your loan – typically enough so that you’re able to avoid LMI. Having a guarantor can also help you take a bigger loan to help cover expenses like stamp duty and other administrative costs.
