What is LMI?
LMI stands for Lenders Mortgage Insurance. Firstly, lets straighten one thing out – LMI does not protect you, the borrower. It is insurance paid by the borrower to protect the lender, for any losses suffered if the borrower cannot meet the loan repayments.
If the borrower defaults on their loan, the lender can recover their losses by repossessing the property connected to the loan however the lender may still incur losses, for example if the property value has dropped so LMI is used to protect them from those instances. LMI doesn’t affect all borrowers and if you are thinking of buying a property it’s important to work out how it is calculated and if it applies to you.
Stop right there! You might be thinking, why do I the borrower have to pay insurance that covers the lender? Well because LMI reduces risk to the lender, it means borrowers who are deemed to be higher risk may still be eligible for loans they otherwise may not be able to access.
LMI is generally applied to borrowers who have a low percentage of deposit because they need to borrow a higher proportion of the property value. Saving a deposit can be hard, especially if you are paying high rents so LMI assists you to access loans without a large deposit and get out of the renting cycle. It can be a tool that is used to get you into your own property sooner but you, not the lender, must pay for the privilege.
When discussing your circumstances with a financial institution or mortgage broker you will be told if LMI applies to the loan you are thinking of applying for. Generally, but not in all cases, LMI will apply if you have less than a 20% deposit of the property value.
How is LMI calculated?
LMI is calculated based on the loan amount and property value. Other factors are also considered such as if you’re a new home buyer or an existing borrower. Even the suburb in which the property is located may be considered in calculating the LMI if it’s an area with significantly higher loan defaults than the national average.
Unfortunately, while you can shop around on various loans available to you, the lender not the borrower determines the LMI provider.
How is LMI paid?
LMI can be paid in a one-off payment at settlement or can be added to your loan amount and paid off as part of your regular loan repayments. It’s important to note that LMI premiums added to your loan will accrue interest and will cost more in the long run.
How can I avoid LMI?
Generally, you can avoid LMI by having a deposit greater than 20% of the loan value. Some lenders will not apply LMI if you have a deposit of less than 20% depending on the loan products available and your circumstances. For example, if you are in a highly regarded occupation such as a doctor or lawyer, these are considered to be stable and highly paid positions and you may not have to pay LMI.
Is LMI worth it?
This question can only be answered by looking at your circumstances and the property market in your intended purchase area. For example if property prices are extremely stable in your area and you have the capacity to save quickly to reach a 20% deposit, then you may be better off saving a higher deposit than paying LMI.
If you are in an area however where property prices are quickly rising and you are unable to save for a 20% deposit quickly, then paying LMI may assist you to get into your property sooner. LMI may also be an option if an opportunity comes onto the property market that is too good to miss or if the cost of LMI is less than the cost you would otherwise spend on rent while saving a higher deposit. In markets where property prices are increasing rapidly it is also important to note the amount you thought would be a 20% deposit could suddenly be a lesser deposit amount as property prices rise.