What is Lender’s Mortgage Insurance

What is Lender’s Mortgage Insurance
Lenders Mortgage Insurance (LMI) is a tool used by lenders to reduce their risk in cases of where borrowers have smaller sized deposits to put down in their loan.
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In a nutshell, lenders mortgage insurance is insurance that protects the lender (not the borrower) in the event the borrower can't make repayments on their home loan. If you've borrowed more than 80% of the value of the property from a financial institution, you will need to pay LMI. Even though it may seem like LMI only benefits the lender, it actually benefits the borrower too because without it, you may be unable to secure finance for your property purchase.

Historically, lenders wouldn't approve where the loan to value ratio (LVR) was higher than 80% as it was considered too risky. The introduction of LMI means lenders can now approve home loan applications with higher LVR (90% for loans.com.au) allowing borrowers to access finance so they can purchase property. 

Lenders mortgage insurance is not to be confused with mortgage protection insurance, which covers borrowers for their mortgage repayments in case of unemployment, disability, sickness or death.

What is lenders mortgage insurance (LMI)?

Lenders mortgage insurance is an insurance policy which covers the mortgage lender against any losses they may incur in the event the borrower can no longer make their mortgage repayments (an event known as a default on the loan).

LMI is only charged in instances where borrowers have smaller sized deposits to put down against their property.

While the deposit % used to trigger LMI can differ from lender to lender, the average figure in the Australian market is around 20% (eg. having a deposit of less than 20% of the loan value would trigger LMI having to be paid by the borrower). 

LMI helps thousands of people each year to purchase a home who otherwise may not have satisfied individual lender criteria. Lenders usually provide borrowers with the option of either paying their LMI upfront or alternatively by adding it onto their loan amount (which is sometimes referred to as 'capitalising' the fee).

Any home loan application where the LVR is higher than 80% results in LMI being required. How much the LMI costs will depend on how much money is borrowed for the home loan. Essentially, the higher the loan value ratio, the higher the mortgage insurance will be. 

In the event the borrower defaults on their mortgage, the lender can recover what's owed to them by repossessing the property the home loan is tied to. If the value of the property has fallen, the lender can suffer a loss - this is the risk that LMI covers. As the risk of loss has been passed on to lenders mortgage insurance, lenders are more willing to approve mortgage applications at a higher loan-to-value ratio.

What is loan-to-value ratio (LVR)?

A loan-to-value ratio (LVR) is the value of the property in comparison to the amount of money being borrowed (through a home loan) and is calculated as a percentage. The LVR is used by lenders to assess the risk factor of a home loan. The lower your LVR percentage, the less of a risk that loan is to a lender. Conversely, the higher your LVR percentage, the riskier the loan is to a lender.

For many lenders, the sweet spot is an LVR of 80% (20% deposit).

How is lenders mortgage insurance calculated?

Lenders mortgage insurance is calculated as a percentage of the loan amount and will vary depending on your loan-to-value ratio and the amount of money you want to borrow. 

LMI costs can differ depending on the loan, the lender, and the LMI provider. The factors that determine the cost of your LMI can also include a few other factors, including whether or not you have 'genuine savings', if you're applying for the First Home Owner Grant, or if you're self-employed - among other things.

How to avoid lenders mortgage insurance

Typically, if you have a deposit of at least 20% you won't need to pay lenders mortgage insurance. This is because lenders perceive borrowers with a deposit of at least 20% as being less likely to default on the loan. A 20% deposit is also a big enough buffer to protect lenders from a drop in the value of the property.

With that said, there may be some instances which require a bigger deposit for suburbs the lender perceives as having high default rates and/or drops in property values. 

Borrowers may also be exempt from paying LMI for other reasons, such as having a guarantor or from working in a highly regarded profession (doctor, lawyer, etc). 

How much does Lender’s Mortgage Insurance cost?

LMI costs at least a couple of thousand dollars in the vast majority of cases, but that’s a low-point. It can easily cost upwards of $10,000 or even $20,000, depending on a number of factors:

  • The cost of the house

  • The size of your deposit

  • Whether you’re a first home buyer or not (this can make it more expensive)

  • The length of your mortgage

And other factors such as your age and employment status.

The table below displays a breakdown of what LMI can cost based on a 30-year home loan for various LVRs (loan-to-value ratios) and property costs.

Estimated Lender's Mortgage Insurance (LMI) Premiums

Estimated property value

95% LVR

90% LVR

85% LVR

$200,000

$ 5,643

$ 3,024

$ 1,649

$400,000

$ 14,174

$ 7,668

$ 4,284

$600,000

$ 28,557

$ 14,634

$ 7,344

$800,000

$ 38,076

$ 19,512

$ 9,792

$1,000,000

$ 47,595

$ 24,480

$ 12,325

Source: Genworth LMI premium estimator. Prices including GST but excluding stamp duty. Based on a loan term up to 30 years.

So as you can see, LMI can be extremely costly, and if you do have to pay it, it can add thousands extra to the cost of your loan.

LMI can be paid upfront as a one-off fee, but if it’s too expensive, you can also capitalise it into the loan and pay it off as a part of your regular mortgage repayments (this would mean the LMI fee would also accrue interest).

Stamp duty on your LMI premium

The costs above exclude stamp duty on the LMI premium, which is different from stamp duty charged on the purchase of a property. Depending on which state you live in, you can also be charged a percentage on your LMI premium:

  • NSW: 9.0%

  • VIC: 10.0%

  • QLD: 9.0%

  • SA: 11.0%

  • WA: 10.0%

  • ACT: N/A

  • NT: 10%

  • TAS: 10%

So, remember to factor this in when budgeting for your house purchase, as it can be an extra few hundred or even a few extra thousand

How is Lender’s Mortgage Insurance paid?

In many cases, Lender’s Mortgage Insurance premium is paid at loan settlement as a one off lump sum. If you wish to avoid having to pay LMI upfront, you can instead include this into your total loan amount and spread the cost of the insurance over the loan.

Take note that if LMI is added to your loan amount, your minimum monthly mortgage repayments will marginally increase to cover the cost of LMI.

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