For most people, especially first-time home buyers, insurance on your home loan is a necessary evil when buying a home. It’s known as Lenders Mortgage Insurance, or LMI, and although you are the one who gets the insurance, it’s not to protect you; it’s there to protect the lender.
What is Lenders Mortgage Insurance?
Lenders Mortgage Insurance is in place to protect your home loan lender in the event that you default on your home loan. Whether or not you need LMI depends on the amount of money you have upfront for your deposit and your particular lender. Most lenders require borrowers to have at least 20 per cent of the purchase price of the home as a deposit, paid upfront. In other words, if you need to borrow more than 80 per cent of the purchase price of the home, then you will be required to pay for LMI. With LMI, you may be allowed to borrow up to 95 per cent of the purchase price of your home, which would require a much lower deposit than is usually necessary. If you need to get a low doc loan (loans that don’t meet the usual proof of income document requirements such as tax returns and financial statements), then you’ll need LMI for anything more than 60 per cent of the purchase price of the home. There are some minor exceptions to this rule depending on the lender and product.
Having Lenders Mortgage Insurance gives you more flexibility with your lender since it gives them a bit of a safety net; in the event that you default on your home loan and the home needs to be repossessed, your lender will be covered by the home loan insurer if the proceeds of the sale aren’t enough to repay the home loan in full.
According to the National Finance Corporation, most mortgage insurance companies will provide Lenders Mortgage Insurance for a variety of residential home loans, including owner-occupied home loans, property investment loans, construction home loans, home improvement or extension loans, interest-only loans, some low documentation loans, home improvement or extension loans, principal and interest loans, and bridging finance loans.
Lenders Mortgage Insurance providers
In Australia, there are five companies that provide Lenders Mortgage Insurance:
Westpac LMI (WLMI)
St George LMI (SGLMI)
As a borrower, you generally wouldn’t have any contact with the home loan insurer because your lender selects the home loan insurer, not you. Each home loan insurer has its own criteria for evaluating the borrower and the property, and it decides whether or not a home loan can be insured. Because of this, it’s possible that your lender may approve your home loan application, but the home loan insurer won’t. In that case, you won’t be able to get a home loan unless your lender decides to try another insurer.
The cost of Lenders Mortgage Insurance
How much you’ll pay for Lenders Mortgage Insurance depends on a number of things, including the size of your loan. The bigger your home loan, the higher the risk that the lender assumes when they loan you the money. The higher the risk, the higher the cost to insure your loan. Another factor in determining the cost is your deposit. The smaller your deposit, the more you’ll pay for LMI because the lender is shouldering a greater portion of your loan. The type of loan product you choose also has an impact on how much you’ll pay. A lenders mortgage inusrance calculator can help give you an estimate on what payment you will need to make.
You can pay for LMI upfront, in a single premium, or it can be capitalised into your home loan. The benefit of paying it upfront is that it’s done; the benefit of paying it over time is that your upfront costs will be reduced, and it’s that much less money you’ll have to bring to the table.
With most insurance policies in Australia including LMI, state and federal government taxes are applied to the premium. These include stamp duty and GST based on the amount or premium being applied to the loan if it is insured.
Lenders Mortgage Insurance exceptions
There are a couple of ways to avoid paying for Lenders Mortgage Insurance. The first way is to have a deposit that’s more than 20 per cent. If you don’t have that, the only other way that you’re getting out of getting it is to have a guarantor on your loan. Having a deposit that’s greater than 20 per cent is pretty simple, although it can take a very long time to save up the amount required to buy a home, especially for first-time home buyers in Australia’s biggest cities.
A guarantor is an immediate family member who allows the equity in their own property to be used as additional security for your loan. This guarantee means that should you not be able to repay your loan, the guarantor becomes responsible for all of it – principal, interest, and any additional fees. Once you have paid off part of your loan or your property has increased in value, you can apply to remove the guarantee.
Is Lenders Mortgage Insurance necessary?
Although Lenders Mortgage Insurance protects the lender in the event that you default on your loan, there is some benefit to you, the home buyer. If lenders home loan insurance didn’t exist, then lenders wouldn’t be able to offer competitive home loan rates to borrowers who are getting high ratio home loans. Rather than assuming all of the risk, lenders share the risk with home loan insurers. So although you’re paying lenders home loan insurance, you’re benefitting from paying less interest on the total home loan amount.
Obviously having as big of a deposit is the best option if you’re buying a home, as it ends up saving you money in the long run. But if you can’t wait to save all of that cash – or don’t want to use all of your available cash up front, then lenders home loan insurance allows your lender to rest easy that they’ll be taken care of should you not be able to afford your home loan.