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Understanding Lenders Mortgage Insurance

If you’re looking at buying your first home, chances are you’ve heard the phrase ‘Lenders Mortgage Insurance’ thrown around, or maybe even the acronym ‘LMI’, but how many of us know exactly what this means?

If you’re anything like most first-time home buyers, you may be totally worried and confused about this supposed extra cost towards buying a home, that only some people have to pay. You may be wondering who pays LMI, why they pay it and exactly what costs are involved.

If you’re new to the property investment world, don’t fret because we’re about to give you the low-down on everything you need to know about LMI, including what it is, how you can avoid it, and why you might need to pay it.

What is Lenders Mortgage Insurance (LMI)?

Lenders Mortgage Insurance is a form of insurance that is paid by the home loan owner but designed to protect the lender, just in case you default on your home loan and can no longer make your repayments.

The important thing to recognise is that not everyone pays for LMI. Usually, LMI is only required when the borrower is taking out a loan for 80% or more of the value of the property (meaning they do not have the ‘traditional’ 20% deposit). This percentage is otherwise known as the Loan-to-Valuation-Ratio or LVR, and in most cases, if your LVR is over 80%, you will most likely be required to pay for Lenders Mortgage Insurance.

An important distinction to make is that LMI is not there to cover you (or your guarantor), it simply exists to protect your credit provider in the event that you cannot pay back your loan.

How do you calculate LVR (Loan-to-Value-Ratio)?

The Loan-to-Value-Ratio (LVR) is used to help determine whether you will need to pay Lenders Mortgage Insurance. Usually, an LVR value of over 80% suggests that you will need to pay LMI.

The LVR can be calculated by dividing the loan amount by the value of your property. For example, if Jenny was getting a loan of $300,000 and her property was worth $450,000, her LVR would be approximately 67%, meaning she would most likely get away with not needing to take out LMI.

However, if Jenny’s LVR was 80% or greater, in most cases she would need to take out LMI.

How is Lenders Mortgage Insurance calculated? How much does it cost?

Lenders Mortgage Insurance (LMI) is usually a one-off payment that lasts for the life of your loan. The cost depends on your Loan-to-Value-Ratio (LVR) as well as the amount you wish to borrow, and generally, as your LVR or borrowing amount goes up, so does the price of your insurance.

What are the benefits of LMI for the borrower?

Despite looking very gloomy, Lenders Mortgage Insurance (LMI) does have some benefits for the borrower that make it well worth your consideration.

Firstly, it allows buyers to take out bigger home loans that would have otherwise been unavailable to them, giving those first home buyers who are trying to break into heavily-inflated property markets a fighting chance.

LMI also means that borrowers are able to buy a home sooner since they do not have to wait until that have the traditional 20% deposit. Depending on the market, as well the buyer’s personal circumstances, despite the extra cost associated with LMI, this could very well leave them better off in the long run.

Of course, whether LMI would be an advantage or disadvantage to you depends entirely on your personal situation. Whilst for some, there may be a benefit to forking out for LMI and entering the market a little soon, for others, it may be wiser to wait and save for a bigger deposit. To assess which camp you sit in, we suggest you carefully consider the market you are trying to buy into as well as your personal circumstances, and if possible, seek the advice of a financial advisor.

Does LMI need to be paid upfront?

Whilst LMI is a one-off payment, with most insurers there is usually some flexibility as to how it is paid.

The first way to pay for LMI is in a one-off, upfront payment. However, although for some people this is no problem, for many others this can be hard, considering that if they had a tonne of money sitting around, they would have been able to meet their minimum deposit in the first place (and avoided LMI altogether).

The second way to pay for LMI is to capitalise the payment into your mortgage. Capitalising LMI into your mortgage essentially means that the cost of LMI is added to your home loan,

meaning that you pay it off in regular installments just like you would with your normal home

loan repayments.

How long does LMI approval take?

The timeframe for LMI approval can differ from insurer-to-insurer so if you’re worried, it is usually better to ask directly. However, in saying this, most insurers should be able to give approval in one to two business days (assuming property valuation has already been completed).

How can I avoid paying Lenders Mortgage Insurance (LMI)?

In most cases, LMI can be avoided by having a deposit that is over 20% of the value of the home. This could mean saving for longer or deciding to buy in a more affordable location, where your deposit will have a bigger ‘kick’.

In some cases, having a guarantor can also allow you to borrow more and help you to avoid paying for LMI. This means having someone in your family, such as your parents, putting some of their house up as equity to help increase yours, effectively making your deposit worth more.

Working out whether or not you will need to pay for LMI, as well as working out strategies to avoid it, is dependent on your individual circumstances so it’s always better to check with your lender (or potential lender) as to whether you will need to pay for LMI.

Is LMI refundable?

In some cases, LMI is refundable within the first one to two years, however, it depends on the conditions of your policy. For some policies, LMI refunds are not available under any circumstances.

For example, under some policies, if the home loan is paid off within a certain amount of time (usually under two years), the home loan owner will be entitled to a refund or partial refund of the cost of their LMI. However, for some home loans, no such clause exists.

In other cases, if within a certain amount of time (again, usually under two years) the homeowner decides to refinance and move lenders, for some policies the LMI can be refunded (or partially refunded). Again, whether this is possible is entirely dependent on your home loan policy.

It’s important to note that, even if your LMI is refunded, if your equity has not increased and your LVR is still greater than 80%, you will most likely still need to take out LMI (again) for the new home loan policy.

The most important thing to keep in mind is that the option of LMI being refundable is not a given, and it will depend on your particular policy – so be sure to ask!

Is LMI transferrable?

Unfortunately, when you move lenders, Lenders Mortgage Insurance (LMI) is not able to be transferred. However, in some cases, if you stay with the same lender, they will give you a discount on the new LMI policy – rather than have you move to a new lender altogether.

The fact that LMI cannot be transferred is an important point for mortgage holders to take into consideration when they consider moving to a new lender, with its implication being that if your equity is still not high enough, you will be required to take out LMI yet again, adding a significant cost to the value of your home loan.

Always consider that although you may be required to take out LMI again, this new lenders policy might be so good that it offsets this added cost. At the end of the day, every circumstance is different and only you, or your financial advisor, can really say which option is best for you.

Wondering whether you’ll be required to pay for Lenders Mortgage Insurance? Speaking to a mortgage broker can help you to assess your borrowing power and whether you’re eligible for a home loan without paying for LMI.