The weird world of Lenders Mortgage Insurance
Lender’s Mortgage Insurance (LMI) is a type of insurance that has been used by millions of Australians who have entered the property market, but it’s a product that isn’t widely understood. So, what is it, when is it used and who is it actually for?
LMI is a type of insurance that is generally required when you are buying a home or investment property and you don’t have a large enough deposit. Generally, it kicks in when you are trying to borrow over 80 per cent of the property value.
LMI is arranged by the lender during the loan approval process and involves a one-off cost, which can often be added to the loan. The premium, which can be many thousands of dollars, is calculated based on a sliding scale that relates to the value of the property, the percentage of the purchase price being borrowed and the loan amount. However, there are other factors that can impact on the figure, such as the type and location of a property.
The biggest misconception about LMI relates to who it actually protects. Although it is paid for by the borrower, its purpose is to protect the lender in the case of a default on the loan. It covers any shortfall that may arise if the lender repossess the property and isn’t able to recover enough money to repay the loan and relevant costs. The clue is in the name. LMI doesn’t benefit the borrower as the borrower would still be liable for a default.
LMI should not be confused with Mortgage Protection Insurance, which covers your mortgage repayments in the event of death, sickness, unemployment or disability.
Some people believe that LMI is overly expensive, especially when you consider that default rates in Australia, even among first-home buyers, are very small. Another common gripe is the fact that refinancing a loan can trigger LMI, even if it was paid when the original loan was approved.
How do you avoid paying LMI? One way is to save enough of a deposit, generally at least 20 percent of the property value. Another way is to have a guarantor, perhaps a family member, provide security to cover an agreed portion of the loan.
As different lenders have different criteria and premiums in relation to LMI, it makes sense to consult with a finance broker who can discuss the pro’s and cons of LMI. Borrowers still may choose to pay LMI if it means getting their home or investment sooner, particularly where costs of a rising market may outweigh the time it will take to save a larger deposit.