If you are a first home buyer you may have heard the term Lenders Mortgage Insurance be mentioned.
In this post I will unpack Lenders Mortgage Insurance, outlining how it is paid, why we have to pay it, the benefits of lenders mortgage insurance as well as tips to reduce it.
What is Lenders Mortgage Insurance?
Lenders Mortgage Insurance or LMI for short, is a once-off insurance premium paid by the borrower to their lender at settlement to cover the lender in the event the borrower fails to make repayments.
This policy comes into effect if the entire loan plus costs is unable to be recovered from the sale of your property.
It is important to note, this policy only covers the lender in the event you fail to make repayments.
Also, the Lenders Mortgage Insurance cost is financed by your loan, and whilst this is an upfront expense, you do not need to have the LMI cost saved as cash.
When do I have to pay Lenders Mortgage Insurance?
Lenders Mortgage Insurance is required when you do not have a 20% plus stamp duty deposit to purchase a property.
For example, if I wanted to purchase a property for $500,000 and I had a deposit of $100,000 plus stamp duty, I would not need to pay LMI.
However, if my deposit was only $50,000 plus stamp duty, I can still purchase the property, I will just need to pay Lenders Mortgage Insurance.
So what are the benefits of LMI?
Whilst LMI is a cost to the borrower, it does come with some advantages. Paying the LMI allows you to get into the property market much sooner than without LMI.
This is due to the lender accepting a smaller deposit size than the standard 20%, meaning you can get into your own home now, rather than wait another couple of years.
The benefits of Lenders Mortgage Insurance are clearly visible in a rising property market, where the capital growth of property outpaces the rate you can save.
Paying the additional cost upfront will allow you to purchase the property now, and receive the benefit of future growth, rather than continue to save, chasing your tail trying to achieve a 20% deposit plus stamp duty.
How is Lenders Mortgage Insurance Calculated?
So you now know why LMI is important, and how it can help you get your dream home sooner, but no-one likes additional fees so here is how to minimise your LMI cost.
To understand minimising LMI, you must first understand the Loan to Value ratio, as this is one of the factors that determine the amount of LMI you pay.
The loan to value ratio is very simple, it is the loan amount divided by the purchase price (if purchasing) or property value (if refinancing).
Lenders Mortgage Insurance is determined by a couple of factors, the main ones being Loan to Value ratio (LVR) and type of employment (employee or self-employed).
Once your LVR exceeds 80%, LMI is payable and will increase significantly every 2% higher your LVR increases.
How $250 can save you $1,725.73 in LMI
Now you understand the determining factors for LMI as well as LVR, here are the two main ways to reduce your LMI cost:
- Reduce your loan amount slightly into a lower LVR category
- Shop around different lenders, ranking them by LMI cost
Firstly, reducing your loan amount into a lower category may save you thousands and it is not as hard as you may think.
Lenders Mortgage Insurance generally has the following LVR categories: 80.01% to 82.00%, 82.01% to 84.00%, 84.01% to 86.00% etc, all the way to 92.00% which is generally the maximum you can borrow with LMI.
So one way to reduce LMI, would be to check your loan amount against the purchase price and find where you stand.
If you are sitting at 88.05%, then dropping back to 88.00% will reduce your LMI significantly. For example on a $500,000 purchase, the additional deposit required would be $250.00, however the LMI drops from $6,563.73 to $4,838.00, potentially saving you an additional $1,725.73!
Now if you are unable to come up with the extra cash to reduce you into a lower bracket, the next best thing is to shop around lenders based on LMI cost.
When looking for a loan, many consider the interest rate, fees and charges as well as features, however many overlook potential savings in LMI.
For example, for a $500,000 purchase with an 88% loan, the lowest cost LMI lender will charge you $4,838.00, whilst the highest cost lender will charge $5,863!
That is potential saving of $1,000, just by comparing the market.
So what is the easiest way to do all of this?
When it comes down measuring the various costs of Lenders Mortgage Insurance with different providers, or reducing your loan amount to limit the LMI cost, there is no better person to speak with then a qualified mortgage broker.
A Mortgage Broker generally does not charge any fees for their service and can assess all of this for you, meaning you do not have waste time shopping around, waiting on hold etc.
Depending on your occupation, you may be eligible for an LMI wavier, this includes doctors, legal professionals and accounting professionals.
Want to learn more about LMI, or looking to enter the property market? Let’s have a chat!
