Lenders' mortgage insurance (LMI) is an upfront fee charged by lenders to home buyers who want to borrow more than 80% of their property value.
At the end of 2021, over 70% of first home buyers took out LMI due to the current state of the property market and rising house prices. Despite this, more than 25% of Australian home buyers have a misunderstanding of LMI and who it actually protects.
In this blog post, we'll unpack everything you need to know about LMI so you can feel confident when taking out a loan over 80% of your property's value.
What is the Purpose of Lenders Mortgage Insurance?
The purpose of LMI is to protect the lender in the occurrence of a shortfall.
If the borrower defaults on their loan repayments, the lender will need to sell the property to recover the outstanding loan amount. However, if the property's sale price is less than the outstanding loan balance, a shortfall debt is incurred. This is where LMI premiums protect the lender, effectively guaranteeing that they are not out of pocket due to your loan default.
While LMI only protects the lender in the event of a default, the cover helps increase the chances of Australians securing a home sooner. This is because LMI effectively allows you to take a loan amount of up to 95% of the property value, meaning you only pay a 5% deposit.
If you would like protection during the event of a default, you should consider mortgage protection insurance.
Mortgage Protection Insurance vs Lenders Mortgage Insurance
Many people confuse mortgage protection insurance with LMI despite being extremely different.
In simple terms, the easiest way to understand mortgage protection insurance is that it protects you (the borrower) if you can no longer meet your loan repayments. This differs from LMI, which covers the lender if you default on your home loan.
Home buyers commonly opt-in for mortgage protection insurance to help minimise the financial risk if they find themselves suddenly unemployed, sick or injured. You can access this cover with mortgage insurance lenders or ask your financial institution if they offer the policy with their loan products.
When Do You Pay Lenders Mortgage Insurance?
A lender will charge LMI if they consider your home loan as high-risk, meaning they suspect you could default on your mortgage repayments.
You can expect to pay LMI if you are:
- Unable to put down a 20% deposit of your property’s purchase price.
- Self-employed and applying for a low documentation loan (only if you borrow more than 60% of your property value).
- A risky borrower, based on information reflected in your poor credit score.
How You Pay
If you need to take out LMI, your lender will contact a mortgage insurer for a quote. Accordingly, there are two methods that people use when paying for LMI:
- Pay the LMI premium as a one-time upfront fee at the time of settlement.
- Add the LMI to your overall loan amount and gradually pay it off during your repayments. However, this amount will be charged with interest rates.
Unless you can afford the upfront payment, most credit providers will lump your premium fee into your total loan amount.
How Much is Lenders Mortgage Insurance?
The exact cost of your LMI fee is impossible to predict, as prices vary between lenders. However, a lender will generally calculate your LMI based on your Loan to Value Ratio (LVR) and the total borrowing amount against other factors, such as if you are a first home buyer.
In a rough estimation, Joust calculates that you could expect to pay up to $20,000 in LMI costs if you're a first home buyer who puts down a $100,000 deposit for a home loan worth $900,000 (10% of property value).
As the cost of LMI changes between lenders, you must do your research on different home loans available and their terms. That's where Joust can help. As a free online home loan marketplace, we provide the best deals in the market to help you secure the perfect home loan.
Lenders Mortgage Insurance in Practice
Here is an example to clarify how LMI works in the event of someone defaulting on their loan payments:
1. John Buys a Home with a 10% Deposit
In 2014, John found the property of his dreams for $1,200,000, but he had only saved enough for a $120,000 (10%) home loan deposit. As a result, John took out a home loan for 90% of the property’s total value, forcing him to pay LMI.
During his settlement, John’s lender added the one-off premium on top of his loan amount, consequently increasing the total amount payable.
2. John Defaults on His Home Loan
In 2022, due to unforeseen personal circumstances, John’s financial situation changed, and he could no longer repay the $650,000 balance left on his home loan. The lender attempts to sell the property during a dip in the housing market to recoup their loss, eventually settling for $600,000.
3. John's Lender Claims the Shortfall
With $500,000 still owing, John’s lender will claim the shortfall from the LMI provider. If John’s initial premium doesn’t cover the full claim, the provider has the right to seek repayment from him through other measures.
Who is Exempt from Lenders Mortgage Insurance?
In some circumstances, your lender may waive your LMI cost. However, this is extremely rare, and you can only qualify if you adhere to strict lending criteria determined by your relevant credit provider.
Your lender may waive LMI if you:
- Take out a loan slightly higher than 80% of the property's total value.
- Work in a specific profession such as law, medicine or finance.
- Invest in a Defence House Australia (DHA) property.
- Are a first home buyer purchasing a home with a guarantor.
To qualify for these exemptions, your lender will explain certain terms and conditions that you must follow. This can include a maximum loan size or minimum annual salary.
How to Avoid LMI
If you think that the cost of LMI is too expensive, there are a few ways that you can avoid it:
- Save for a 20% deposit: it’s the most obvious option, but spending a little more time saving to ensure you can afford a 20% will save you thousands of dollars in the long run.
- Take out a guarantor loan: A guarantor home loan involves using someone else’s property as security for your loan, such as a friend or family. Banks tend to be more willing with a guarantor and will lend as much as 110% above the property value without LMI.
- See if you qualify for the First Home Buyer Deposit Scheme: This scheme enables first homeowners to pay as little as a 5% deposit, with the government guaranteeing the rest, allowing you to avoid LMI.
The best option is to utilise a financial expert for personal advice on avoiding LMI and finding the right lender.
Joust Instant Match can help in these circumstances. Our online loan matchmaker helps borrowers find the best rates that suit their financial needs and wants.
LMI vs Bigger Deposit
Home buyers often stress over the debate on whether to save for a 20% home deposit or take out a larger loan and pay LMI.
When considering that the 2022 median residential house price in Australian capital cities is $1,066,000, the idea of a 20% deposit can seem like a daunting financial task.
At the end of the day, you need to consider your own financial situation and go with what feels best for you. To help come to a decision, try asking yourself the following questions:
- What is the current state of the housing market? If prices are going up, it may be worth considering waiting for a dip in prices and continuing to save. However, if prices are dropping (especially with the interest rate hikes), capitalising on this opportunity and securing a house without the full 20% deposit may be worth considering.
- Are you paying rent? If you're currently paying rent, you could use this money towards future mortgage repayments. It may be more cost-effective to secure your own home rather than continue renting in this instance. Try using our free Rent vs Buy calculator to help you come to a conclusion.
- Are you financially secure? Knowing that you can confidently and consistently meet your home loan repayments in the future may convince you to buy a house without a full 20% deposit.
Let's have a look at a practical example to help determine when to take out a loan greater than 80% of a property's value.
Scenario: Claire’s First Home
Claire is a middle-income earner struggling to save for a 20% deposit on a house in Sydney, roughly around $300,000. Claire has saved $100,000 over the past five years, and she has noticed that prices have started to dip due to the news of interest rate hikes. Currently, Claire has solid full-time employment and pays $400 rent per week, an annual total of $20,800.
Given that house prices are starting to drop alongside Claire's financial security, she could consider purchasing a home without the 20% deposit and take out LMI.
However, as previously stated, it comes down to your personal preferences and financial situation. Before committing to a property, you should always consult a financial professional for qualified and expert advice personal to your specific circumstances.
Is LMI Rolled into My Loan?
If you cannot afford to pay the one-off upfront premium fee, you can have your LMI rolled into your loan. However, this sum will also earn interest, resulting in you paying more on your loan.
Is LMI Tax Deductible?
Similar to stamp duty and GST, LMI is a tax-deductible expense. The total amount deductible depends on the amount of time the property was on the rental market (if LMI is charged halfway through the year).
Can LMI be Refunded?
Only in certain circumstances will a lender refund LMI. This solely relies on whether the lender provider partially agreed with the lender to partially refund the LMI fee.
Do I Need to Pay LMI When Refinancing?
Yes. If you decide to refinance and still need to borrow more than 80% of your home's value, you will need to pay LMI again. As LMI is specific to the lender, the fee cannot be transferred across.