What is lenders mortgage insurance and why do you have to pay it?

What is lenders mortgage insurance?

Lenders mortgage insurance (LMI) is a one-off cost added to your home loan that lets you borrow more than 80 per cent of a property’s value.

LMI is generally only payable by the borrower on loans that are more than 80 per cent of a property’s value. Ray Hair, general manager (sales) at Homeloans.com.au describes LMI as ‘a risk-mitigation strategy’ used by lenders.

“The purpose of LMI is to protect a bank or other lender should the customer default or fall in arrears on their loan repayments,” he says.

When and why do you have to pay it?

“Although on paper a customer may be able to service a loan at the time it was issued, unforeseen circumstances can arise that impact that customer’s ability to make their repayments,” explains Hair.

“Job loss, divorce, ill health and even having a baby may make it difficult for someone to make their loan repayments, and LMI covers the lender should the borrower default on the loan where such a situation arises.”

Hair says it’s important to remember that it’s not the customer being insured by LMI, but the lender.

“It’s insurance for the bank. That’s why you can’t choose the insurer or negotiate cost of the premium.”

How much is it?

LMI insurers take into account the individual lender’s risk profile when determining the premium they will charge. As a result, different lenders’ LMI premiums are slightly different.

The following table provides an indicative LMI cost on a $300,000 loan:

How can you avoid LMI?

Banks and other lenders generally pass the cost of any LMI premiums only on to those customers borrowing more than 80 per cent of a property’s value.

“There really are no exceptions to this, so if you want to avoid LMI altogether, you need at least a 20 per cent deposit,” says Hair.

“The smaller your deposit, the higher the LMI premium, so saving a decent deposit is the best way to avoid LMI or at least keep the premium down as low as you can.”

Are there any benefits to paying LMI?

While paying your lender’s insurance premium doesn’t sound like much of a positive, Hair says there is an upside.

“Over the years, lenders mortgage insurance has allowed more people to enter the property market than would have been possible if the only option was to save a 20 per cent deposit.”

Particularly when the property market is rising, you may be able to cover the cost of the LMI premium through increased capital growth.

“If you’ve paid a few thousand dollars for an LMI premium on a $350,000 property that’s then worth $380,000 after 12 months, you’ve more than made your money back.”

What to look out for

Hair cautions against overstretching yourself by borrowing close to 100 per cent of a property’s value.

“If you take out a loan at 95 per cent of a property’s value, chances are you’ll also be rolling the LMI premium into the borrowings, which can effectively take the overall borrowings closer to 97 or 98 per cent of the property’s value.”

“For buyers in this situation, it pays to be quite disciplined, pay the loan down as quickly as you can and build up some equity in your property. That way you’re in a better position should interest rates start to rise or your circumstances change.”

“Don’t fall into the trap of borrowing more to pay for a car or landscaping!”

Lenders mortgage insurance (LMI) is payable on loans for more than 80 per cent of a property’s value. Although you can avoid it by having a 20 per cent deposit, this is not achievable for everyone and LMI opens the door for many buyers to enter the property market.