Purchasing a home is a major achievement, though it can present various challenges. One of these challenges is dealing with Lenders Mortgage Insurance (LMI). For many first-time home buyers or those with a smaller deposit, LMI can seem like an unavoidable cost. But is it necessary, or are there ways to avoid it?
In this blog, we will break down lenders mortgage insurance explained, explore why it’s required, and provide practical advice on how to avoid paying LMI where possible.
Let’s Get Straight To The Point
Lenders Mortgage Insurance (LMI) protects the lender if you default on your loan, and it’s required when your deposit is less than 20% of the property’s value. While it can be costly, there are ways to avoid it, including saving for a larger deposit, using a guarantor, or looking for LMI-free loan deals.
First-time buyers may also have access to exemptions or government grants. Understanding how LMI works can help you make informed choices and save money in the long term.
What Is Lenders Mortgage Insurance (LMI)?
Lenders Mortgage Insurance (LMI) is a policy designed to protect the lender if you default on your home loan. This insurance doesn’t protect you, the borrower. Instead, it safeguards the bank or lender against potential losses if you can’t repay your loan. LMI becomes necessary when a borrower has a small deposit — typically less than 20% of the property’s value.
While LMI covers the lender, the insurance cost is usually passed on to the borrower. When borrowing more than 80% of a home’s value, you’ll likely have to pay LMI, often as a lump sum or as part of your loan repayments.
Why Do Lenders Require LMI?
Lenders ask for LMI to mitigate their risk. When you borrow a more significant proportion of the property’s value, the likelihood of default increases. By having LMI, the lender is financially protected if you fail to meet your loan repayments.
Many people find saving up for a 20% deposit increasingly tricky as home prices rise. In this situation, LMI helps individuals secure a mortgage without needing a larger deposit. However, LMI is an additional cost that buyers must consider when applying for a loan.
How To Avoid Paying LMI?
While LMI may seem unavoidable for many, there are strategies to reduce or avoid this cost. Below are some practical tips to help you avoid paying LMI.
1. Save A Larger Deposit
The most straightforward way to avoid paying LMI is to save for a larger deposit. If you can put down 20% or more of the property’s value, you won’t be required to pay LMI. It might take time to save this amount, but the long-term benefits of avoiding LMI can make it worthwhile.
2. Use A Guarantor
Another way to avoid LMI is by using a guarantor. This usually involves a parent or close relative offering their property as security for your loan. Using a guarantor, the lender might approve your loan without requiring LMI, even if your deposit is below 20%.
However, it’s important to note that this option carries risks for the guarantor, as they are ultimately responsible for your loan if you default.
3. Look For LMI-Free Lender Deals
Some lenders offer special LMI exemptions as part of their mortgage deals. These deals often come with specific criteria, such as the property type, the loan-to-value ratio (LVR), or the borrower’s financial situation. If you qualify for such an offer, you may be able to avoid paying LMI entirely. It’s worth shopping around and discussing your options with a mortgage broker.
4. Consider A Family Pledge
A family pledge can also help you avoid paying LMI. This is similar to using a guarantor, where a family member offers their property as additional security for your loan. However, in this case, the security is often provided for a specific percentage of your loan amount, which helps you reduce your LVR and potentially avoid LMI.
5. First Home Buyer LMI Exemption
For first home buyers, there may be unique first home buyer LMI exemption schemes that allow you to avoid LMI. Some state governments in Australia offer incentives and assistance for first-time buyers, which might include exemptions from LMI under certain conditions. It’s essential to check the eligibility criteria for these schemes, as they vary by state.
LMI Costs
One of the main concerns homebuyers have when it comes to LMI is how much LMI costs. The cost of LMI depends on several factors, including the size of your loan and deposit and the LVR. Generally, the higher the LVR, the higher the cost of LMI.
The cost of LMI in Australia can range from a few hundred dollars to several thousand, depending on your loan amount and deposit size. On average, LMI costs can range from 0.5% to 2.5% of the loan amount. This means that for a $500,000 loan, the cost of LMI could be anywhere from $2,500 to $12,500.
LMI Calculations
To calculate LMI, the lender assesses your loan amount, deposit size, and LVR. The higher the LVR, the higher the cost of LMI. Additionally, some lenders may charge higher premiums based on the type of loan (for example, a high-risk loan or a low-doc loan).
LMI is calculated as a percentage of the loan amount, and this percentage varies depending on the factors mentioned above. For example, if you’re borrowing 90% of a $500,000 property value, your LMI premium might be calculated as a percentage of that $450,000 loan.
The cost of LMI is often factored into loan repayments, but some lenders may require upfront payment.
LMI Vs Larger Deposit Comparison
One common question is whether paying LMI is worth it compared to saving for a larger deposit. The decision depends on your situation.
If you have the time and discipline to save a larger deposit, avoiding LMI can save you substantial money. However, if waiting to save up a 20% deposit will significantly delay your home purchase, then paying LMI might be a more practical option.
For example, if you buy a home worth $500,000 and borrow $450,000 (90% LVR), the LMI could cost you around $10,000. If you wait to save an additional $50,000 to reach a 20% deposit ($100,000), you could avoid paying LMI altogether. However, this delay may not be ideal if property prices rise and you risk missing out on the home you want.
First Home Buyer Mortgage Insurance Tips
First-time home buyers have specific challenges when it comes to mortgage insurance. Here are some first home buyer mortgage insurance tips to help you navigate the process:
- Check for Government Grants or Exemptions: Depending on where you live, government grants or exemptions may be available for first-time buyers. These can help reduce or eliminate the need for LMI.
- Save a Larger Deposit: While it may take longer, saving a larger deposit (over 20%) is one of the most effective ways to avoid LMI.
- Look for LMI-Free Loans: Some lenders offer deals where LMI is waived for first-time buyers, so shop around and compare options.
- Consider a Co-Owner or Guarantor: If you have family members willing to assist, they could act as a co-owner or guarantor, helping you avoid the cost of LMI.
LMI Refund Eligibility
In certain situations, you may be eligible for an LMI refund. For example, if you pay LMI upfront and then reduce your LVR below 80% within a year (for example, by making extra repayments), you may be eligible for a refund of part of the LMI premium.
The eligibility for the refund depends on the lender and the specific conditions of your loan. If you qualify for a refund, contact your lender to inquire about the process and how much you can reclaim.
In conclusion, Lenders Mortgage Insurance (LMI) protects lenders when your deposit is under 20%. While it can be costly, you might avoid it by saving a bigger deposit, using a guarantor, or tapping into first home buyer schemes. Understanding LMI helps you make smarter loan choices—avoiding it could save you thousands, but if it’s unavoidable, be sure to budget for it.
