Are you motivated to get into the property market but haven’t had the time to save a suitable deposit? Are you self-employed and struggle to prove to lenders you have a stable income?
If you answered yes to either of these questions, don’t be disheartened, you still have an opportunity to purchase that dream property.
This article can help provide information to help you buy a property sooner but it’s imperative to understand what Lenders Mortgage Insurance (LMI) is, its benefits and pitfalls, and how it’s calculated before you take the plunge.
What is lenders mortgage insurance?
Lenders mortgage insurance (LMI) protects your lender in the event you can’t make your mortgage repayments – essentially, an insurance policy that protects the lender from financial loss.
It is, however, an insurance policy you pay for, not the lender even though the lender is the protected party. In this way, lenders mortgage insurance is a unique type of insurance product. In most instances, the party paying the premium is the party buying protection.
With the ability to pass on shortfall risk to the insurance company, lenders are more willing to accept a lower deposit. So, by reducing the deposit required, borrowers can purchase a home much earlier rather than having to wait until they saved the more standard 20 per cent deposit.
In a rising market, paying LMI (meaning lenders mortgage insurance) and buying sooner could be cheaper than the extra dollars needed to secure a property in a year’s time if prices rise dramatically during that period.
If your loan is high risk – for example, if you’re taking out a large loan that’s more than 80 per cent of the property value, or if you don’t have proof of income and employment history – then you may be required to pay an LMI premium. This will cover the lenders repayment shortfall if the property is ever sold at a loss, thus reducing your risk to them as a borrower.
LMI means that even with a small deposit, you have the potential to own your home sooner, allowing the lender to have confidence in offering you a home loan, because it knows any losses will be covered.
How is mortgage insurance actually calculated?
With LMI in place, many lenders will allow you to borrow up to 95 per cent of the purchase price of your home.
How to calculate LMI?
Lenders mortgage insurance is calculated with the assistance of an LMI calculator as a percentage of the loan amount. Your LMI amount will vary depending on your Loan-to-Value Ratio (LVR) as well as the amount of money you wish to borrow.
The LVR is the proportion of money you borrow compared to the value of the property with the difference equating to your deposit.
The percentage you are required to pay increases as the LVR and loan amount increase and usually goes up in stages.
Lenders mortgage insurance explained: Lenders mortgage insurance costs differ depending on the loan, lender and the LMI provider. Some institutions will self-insure for deals up to a certain LVR.
Our advice is to shop around as LMI premiums can potentially differ by thousands of dollars between providers. You can start by using the LMI calculator on the website of different lenders to get an understanding about costs. An LMI calculator will give you a good ballpark figure, but of course, for more information and before you make any decisions, make sure you talk to the different lenders attached to each LMI calculator.
In saying this, we have all the tools at our disposal and it’s one of the things that a qualified mortgage broker will do for you in weighing up the LMI costs in conjunction with your overall interest rate outcome.
When do you have to pay LMI?
You can pay LMI as a one-off lump sum at the establishment of the loan, or it can be capitalised onto the loan repayments which is what most borrowers end up doing. LMI is generally paid at settlement with all other lender and government charges.
Percentage of the Loan Amount
Let’s take a look at when LMI is a consideration for a variety of property purchases.
Standard Property Purchase
Usually you will pay LMI on your home loan if you are borrowing more than 80 per cent of the property value on a standard loan, or more than 60 per cent of the property value on a low doc loan.
The danger with a 90 per cent home loan for a lender is that your monthly repayments and loan terms are higher than they would be if you had a 20 per cent deposit or more. For this reason, LMI is usually charged. (As mentioned, a lenders mortgage insurance calculator will help you to get a more accurate understanding of how much you will be charged).
Low documentation, or low doc, loans are designed for the self-employed who don’t have the necessary documents required to get traditional home loans and usually carry higher interest rates and require LMI, which adds to the overall cost.
Changes recently announced to the way self-employed borrowers are assessed may make borrowing more accessible for this group of borrowers.
Here’s an indicative guide on the cost of LMI. See a specific lenders mortgage insurance calculator for a more detailed result according to your preferred lender:Purchase price Cost of lenders mortgage insurance
5% deposit 10% deposit 15% deposit
$300,000 $7,091 $4,101 $2,186
$400,000 $11,897 $6,944 $3,770
$500,000 $14,872 $8,680 $4,713
$600,000 $23,954 $13,284 $6,463
$700,000 $27,947 $15,498 $7,540
Quotes taken from Genworth LMI calculator, correct as at 10/9/2020.
Based on first homeowner purchase and loan term of up to 30 years.
There are some “tricks” to be able to minimise mortgage insurance costs and most people don’t know that premiums rise in 2% increments. Knowing this, and getting the right LVR in place can save people thousands of dollars from the outset.
A reverse mortgage allows homeowners to access a lump sum or an annuity using their home as collateral. It’s getting a loan against a property you already own and usually accessed by older homeowners who have already paid off their home loans.
You wouldn’t normally be charged LMI on a reverse mortgage.
The benefit of reverse mortgages is that borrowers can continue to live in the property until they die, or they can use the funds for aged care/accommodation/health services, etc.
Lenders mortgage insurance is often required when buying property off the plan, such as a unit in a to-be-constructed development.
There are many pitfalls around purchasing a property before it has been built and there are no guarantees the property you purchase will rise in value between when you contract to buy it and when it’s completed. In fact, it’s not uncommon to see properties valued lower than their original purchase price, thus risking a client’s ability to fulfil the purchase.
Some of the reasons why this might happen are:
- You are paying the property’s component of the developer’s profit margin as part of the price,
- If the property was sold by a third party, rather than the developer, the agent is often paid fees (sometimes exorbitant) to complete a sale,
- If someone can’t complete a purchase there may be a “forced” sale that might be adopted as a comparable sale and will this affect the valuation of other properties in the development,
- there may also be a number of similar development projects about to complete in the same locality, thereby affecting the property’s overall value due to concentration risk,
- Similarly, a flurry of apartment construction during a “boom” will result in an oversupply – and second-hand units (i.e. for sale by their first owner) will be discounted heavily to compete with new units.
In fact, we at Intuitive Finance in Melbourne believe that investors who purchased off-the-plan properties are more exposed to short-term losses. The risks are enhanced when there are changes within the lending environment which can render a once qualified borrower unable to secure funds at the time of settlement. This can have a domino effect, as ‘forced sales’ drive down prices for other unit in a project.
Vacant & unregistered land
Unregistered residential land is land that’s available for purchase before a certificate of title is available. New home builders are unable to start construction on these sites until the land is registered and council has provided a building approval for the individual lot.
If, for some reason, the developer can’t proceed with the project, there can be substantial costs and potential risk for any funds the lender releases.
The key for the lender is to ensure that moneys advanced are properly secured. For this reason, balance funds are unlikely be forwarded for settlement until the block is registered and title.
Another consideration is the nature of vacant land values. When the economy is weak, vacant land tends to fluctuate in value, and may take longer to sell. This is particularly true in regional areas and remote locations.
Conversely, established homes in higher density locations tend to have more potential buyers and sell much faster.
As such, banks can be more conservative when approving a home loan for vacant land as a result of the higher volatility of land prices, and this may result in a buyer needing a larger deposit and/or using LMI to complete the transaction.
This is a form of title where, unlike freehold, the buyer is purchasing a lease to occupy and utilise the property.
So, effectively, the value of the asset is a function of how long the lease runs for, and what the rent is. For example, some properties are on a perpetual lease with a nominal rent – sometimes referred to as a ‘peppercorn’ rent, because your rental commitment is legally one peppercorn per year. That type of leasehold is very similar to freehold in all but name.
Examples of leasehold land exist in Canberra and also in Alpine areas where the land remains government owned and you – as the ‘buyer’ are actually entering into a long-term lease arrangement.
There is a paradox when it comes to LMI and leasehold properties.
Most times, you will be required to pay LMI on a leasehold if borrowing more than 60 or 70 per cent of its value. If a lender needs to foreclose on a leasehold property, they can’t rely on your being able to sell the asset to make up any shortfall, because you don’t own the freehold. It would be unusual to secure a loan on a leased property without LMI.
The problem with leased property is you generally can’t borrow against it, therefore most insurers won’t take the risk.
There are various reasons for refinancing:
- To access a lower interest rate,
- Debt consolidation,
- An opportunity to invest elsewhere arises,
- More borrowing required due to the need for property improvement or new household costs (e.g. education for the kids) arise,
- If your circumstances have changed or if you’ve had your home loan for a few years, Refinancing can offer you the chance to take advantage of more flexible features.
When refinancing your loan, not only is there no refund on the lenders mortgage insurance premium, regardless of how soon you refinance, you will have to pay it again if your loan is more than 80 per cent of the value of your home.
Even though the lender you originally placed your loan with is no longer at risk should you default, the lender that you refinance with isn’t covered. The real problem for homeowners wanting to switch lenders, say from NAB to Westpac, is the potential double payment of LMI. It generally isn’t possible to transfer your mortgage insurance if you switch lenders.
The ‘double dipping’ of LMI in these circumstances continues to be a hot topic among the industry, but unless there are regulatory rules put in place to change the practice, then expect the status quo to remain.
Top up Mortgage Insurance
If you have originally paid mortgage insurance on your property, and your property’s value increases in the future, you might want to use the equity you have gained for another purchase or purpose. Under these circumstances you may choose to increase your loan back to within the original LVR and simply pay a small top-up LMI premium.
This is a very effective way to access equity within an original premium.
Many lenders will offer incentives from time to time and take on a little more risk occasionally.
It is not uncommon for lenders to offer up to 85 per cent of a home loan with no LMI. But there is a catch – most of the time you will pay a small premium on your interest rate. That said, this can be an attractive option in some circumstances.
Mortgage Insurance Waivers
Major banks like to target some professions by offering Mortgage Insurance waivers on up to 90% LVR in some cases.
Specifically targeted professions are the wider medical professions, dentists, chiropractors, physiotherapists and all related medical services. But you need to check this as each lender has different rules.
And some lenders target Accountants, Lawyers and others with specific university qualified degrees.
For more information on this, you should contact us as we specialise in these areas.
Frequently Asked Questions
How can I avoid paying LMI?
As is evident from this article, the way to avoid lenders mortgage insurance is to have a deposit of 20 per cent or more of the property purchase price.
Ways to save the 20 per cent deposit required could include asking your family to chip in, finding a higher paying or secondary job, or allowing yourself more time to grow your deposit.
Does a family guarantee help me avoid paying lenders mortgage insurance?
Firstly, what is a family guarantee?
Well, this is when a parent or close family member allows their home or investment property to be used as equity for a proposed purchase to lower your LVR and help you avoid paying LMI. This is very effective in helping first home buyers enter the market but can also be used for clients wishing to buy an investment property.
The obvious benefit for this is the avoidance of LMI, however it must be noted that the guarantor’s property is then linked to the transaction until such time as the property’s value has increased or the loan has decreased back to an LVR of 80%.
What is difference between Lenders mortgage insurance (LMI) and mortgage protection insurance (MPI)?
Lenders mortgage insurance (LMI) covers your lender – the institution providing your loan – in the event you can’t make your repayments. If the lender needs to foreclose on your loan, then LMI covers the lender for any losses once the property is sold.
Mortgage protection insurance (MPI) is a policy taken out to protect you if you are not able to make your mortgage repayments. Policies are arranged to cover your mortgage repayments in case you lose your job or suffer a serious illness, injury or even death.
In some instances, mortgage protection insurance may be tax deductible, particularly if you are taking it out for an investment property.
Top tip: Don’t confuse mortgage property insurance with mortgage protection insurance. These two terms refer to very different concepts and it’s easy to mix them up.
Mortgage property insurance is simply LMI. Mortgage protection insurance is insurance you take out in case something happens to you and you can’t make your mortgage payments.
We have a reliable, cost-effective insurance partner, so we can also help you organise an affordable mortgage protection insurance policy if you need one.
I heard that home loans also need to be approved by the LMI Insurer. Is that true?
Applications for home loans that lenders deem high risk have to be approved by mortgage insurers. This is because the lenders mortgage insurance provider is assuming the risk from the lender.
Conservative mortgage insurers require the borrower to have a credit history with no blemishes, a savings record and stable employment.
What do I do if my home loan has been rejected?
If your application for a home loan is rejected because of an LMI provider’s criteria, seek advice from your mortgage broker. You could apply for another home loan with a lender who self-insures or uses a different LMI provider.
How much can I borrow for an investment property?
How much you can borrow depends on your current financial status and is assessed on a number of factors including your income, savings, current financial commitments, credit history and living expenses.
LMI, meaning lenders mortgage insurance, is often an expensive cost that is best avoided if possible.
Understanding how mortgage insurance is calculated, now that you’ve read this article, will empower you to make informed decisions about your mortgage provider.
Also, understanding how mortgage insurance is calculated means you have taken big strides in your own financial literacy skills.
Intuitive Finance – the smart choice
Navigating property lending and handing LMI insurers isn’t easy.
Having a professional team on your side could make all the difference to your success.
Now more than ever, you need investor savvy people working on your team.
The world of banking and finance can be a pretty daunting one for both novice and sophisticated investors and since our establishment in 2002 we’ve focused on providing outstanding service and business standards.
This approach was vindicated when we received the Finance Broker Business Award at the 2018 Mortgage and Finance Association of Australia (MFAA) Excellence Awards. For expert advice on lenders mortgage insurance, contact Intuitive FinanceThe information provided in this article is general in nature and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information you should consider the appropriateness of the information with regard to your objectives, financial situation and needs.