What is LMI and why do you have to pay it?
Thursday, 30 April 2015
LMI stands for Lenders Mortgage Insurance and it is designed to provide lenders (banks and home finance providers) with an extra level of protection in case the borrower defaults on (can’t repay) their loan.
Even though about 20% of all mortgages in Australia are covered by LMI, there is often confusion among home buyers about what it actually is for and how it works. Some people even pay it thinking that it is an insurance to protect them, instead of their lender.
LMI is generally a one-off fee charged by the lender to home buyers who need to borrow more than 80% of the value of the property. This means that if you haven’t saved a deposit of 20% of the property price, you’re probably going to have to pay LMI. Since it is extremely difficult to save a deposit of more than 20% ($80K for a $400K property) most first home buyers will be required to pay LMI.
LMI does not provide protection for you as the borrower, but is a type of insurance that will assist the bank or lender to recover any losses should a home buyer be unable to repay their home loan.
The cost of LMI 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.
Can you avoid it?
The first way to avoid paying LMI is to save enough money upfront for a deposit so it isn’t required. In most cases, this will mean saving a deposit of a t least 20% of the value of the property, as well as saving the additional money to meet other fees and charges. This can be very challenging for first home buyers.
Another option to avoid LMI is to find someone willing to be a guarantor on your loan. This means they assume the risk if you default on your loan. In a worst-case scenario, it could lead to the guarantor losing their own home, so it’s a decision that shouldn’t be made lightly.
An alternative is to seek out a lender who doesn’t charge LMI. HomeStart doesn’t charge LMI, but instead, allows home buyers to borrow up to 97%* of the value of the property, while 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**.
Other things to know about LMI
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.
Also, rolling the cost of LMI into your borrowings could bring you close to borrowing 100% of the property’s value, so if this is the case, it’s a good idea to be disciplined and pay down the loan as quickly as possible to build up some equity in your property.
LMI provides a quicker pathway into home ownership, with more people able to enter the market than what would be possible if a 20% deposit was compulsory. However, instead of simply assuming the cost without question, it is important for home buyers to recognise what they are paying for and that there are options to avoid LMI that could leave them thousands of dollars better off.
*Graduate and Low Deposit Loans
**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 April 2015