When shopping around for a home loan, unless you have saved a deposit of at least 20%, chances are you will encounter Lenders Mortgage Insurance (LMI).

LMI is a type of insurance that has become much more prominent since the Global Financial Crisis (GFC) and is designed to provide lenders with an extra level of protection against a borrower defaulting on their home loan.

Despite the fact LMI is now extremely common, there remains a significant amount of confusion among home buyers about what it is, how it works and who it protects.

LMI generally works by a lender charging a one-off premium to home buyers who need to borrow more than 80% of the value of the property. This can range from $5000-$15,000 depending on the size of your deposit and how much you need to borrow. The LMI amount is normally added to your home loan.

It is important to reinforce that LMI doesn’t provide protection for you as the borrower, but is actually a type of insurance that will assist the lender to recover any losses should a home buyer be unable to repay their home loan.

Additionally, LMI is not portable, so should you choose to refinance your home loan after only a short period, you may be required to pay LMI again with the new lender.

Currently, about 20% of all mortgages in Australia are covered by LMI* and even though there are means of avoiding it, many home buyers simply continue to pay the premium.

The first way to avoid paying LMI is to save enough money upfront so it isn’t required. In most cases, this will mean saving a deposit of at least 20% of the value of the property. On a $300,000 house, this would equate to a deposit of $60,000, as well as saving additional money to meet other fees and charges associated with buying a home.

Given upfront costs are already one of the major hurdles to home ownership, it’s likely to take most young people with moderate incomes a significant number of years to raise this amount of money, so in reality, it may not be an option for many home buyers.

An alternative is to seek out a lender who doesn’t charge LMI. HomeStart Finance is one such lender, and enables home buyers to borrow up to 97% of the value of the property, while only charging a Loan Provision Charge (LPC) instead of LMI. The LPC provides similar protections to LMI, but on a $300,000 loan, a $1,195 LPC cost could mean a home buyer would pay approximately $6000 less than they would if they had to meet the costs of LMI**.

A final option to avoid LMI is to find someone willing to be a guarantor on your loan. This, however, is a significant decision that involves risks for all parties involved. In a worst-case scenario, it could lead to a guarantor losing their home, so isn’t a decision that should be made lightly.

At its most basic, LMI provides a quicker pathway into home ownership. However, instead of simply assuming the cost without question, it is important for home buyers to recognise that there are options to avoid LMI that could leave them thousands of dollars better off.

* understandinsurance.com.au
** On a loan amount of $285,000 for a property value of $300,000, HomeStart’s LPC will cost approximately $1,195 compared to LMI of $7,934 (ANZ) and $7,542 (Westpac). LMI and LPC are approximate figures only, with figures sourced online and correct as of June 2014.