Interested in buying your own home but not sure if you will have enough for a deposit? Lenders Mortgage Insurance could help you secure your home sooner without making as big of an up-front financial investment.
Getting your own home is quite the milestone for every person in their life. However, like most things, it usually comes at a high cost.
One of the difficulties of saving for the cost of a home is the lack of understanding over what expenses you’ll be facing while attaining it.
The home loan deposit is one of the first costs that you would have to plan and save for, as it can affect several other expenses that you would encounter while navigating the property market. For example, homebuyers may have to cover lenders’ mortgage insurance (LMI) if their deposit amount doesn’t quite reach a certain number or percentage of the property price.
Trying to learn about LMI may spark several questions, from how much the initial deposit should be for an LMI and what exactly is an LMI in the first place. If you’re curious to learn more, continue reading this article which will cover who needs to purchase LMI and how much you can expect to pay for LMI.
What is LMI?
Lender’s mortgage insurance – or LMI – is an insurance policy that many home loan borrowers or home buyers have to take out when they’re trying to attain funds for a property.
LMI is a one-off payment that home loan borrowers have to pay if they borrow more than 80% of the home’s value – in other words, if you do not have a 20% house deposit.
As a home buyer, if you have – and are willing to pay – 20% or more of your home’s value, you will not need to take out LMI.
How Does LMI Work?
Some mortgage lenders will require homebuyers to take out LMI if their deposit is not high enough.
The primary purpose of LMI is to protect the lender from monetary losses if a borrower cannot afford their home loan repayments.
Without LMI in place, lenders can be disadvantaged if home borrowers do not pay their mortgage repayments. If there’s an LMI in the equation and a borrower decides to default on their home loan, this means that a lender is entitled to get the unpaid value of the mortgage to make up the difference.
LMI works when a lender makes a claim for any defaults a borrower may have made on their home loan. Borrowers will have the option of paying upfront, but they can arrange for the fees’ integration into the overall cost with the home loan. Interest may increase with the latter option.
LMI also allows banks and other financial establishments to lend higher amounts to homebuyers and get more home loan applications approved.
The terms surrounding LMI are a little more complex than your average home loan; the funds you put into this insurance policy are considered non-refundable. This can discourage borrowers from switching home loan providers in the future. If not, they risk forking over additional cash.
LMI certainly favours the lender rather than a home buyer. But there are several other ways that an LMI is utilised during the process of trying to get a loan.
Is LMI Required?
LMI isn’t always a required cost for a home buyer, though it can depend on which lender you’re speaking to.
LMI is usually agreed upon when a home loan deposit reaches less than 20% of the whole property’s value. It’s often a case-to-case basis, as home loan deposits can also fluctuate depending on who you’re dealing with and the property market.
There may also be cases where LMI will be required by a lender depending on the loan-to-value ratio, or they will just voluntarily request it for their own self-protection regardless of the deposit amount or loan terms.
Many can utilise LMI rather differently, and each borrower is responsible for getting the whole picture of what a lender’s policy is. This is why it’s essential to talk to reputable, trustworthy lenders.
Who Needs LMI?
Generally speaking, home buyers with less than 20% of the property’s ‘lender-assessed value’ will need to take out Lenders Mortgage Insurance.
If your deposit is less than 20% of the lender-assessed value, it means you have a Loan to Value Ratio (LVR) of more than 80%. In this case, you will likely be required to pay for LMI.
How can you Avoid Paying LMI?
LMI is a big expense and something that many home loan borrowers prefer to avoid.
There are ways to avoid paying LMI:
- The First Home Loan Deposit Scheme: this can allow first home buyers to take out a home loan with only 5% deposit without having to pay LMI.
- Leverage your employment: Some banks and lenders may offer an LMI waiver, if you earn a high salary and you have a strong employment history. This can include doctors, accountants, solicitors and entertainment professionals.
- Keep your loan to value ratio (LVR) below 80%: If you have a 20% deposit (which is an LVR of 80%), you don’t have to pay LMI.
- Use a Guarantor: You can avoid LMI if a family member guarantees part of your loan.
How Much Is LMI?
How much your LMI is will depend on your situation. In general, the higher the risk of defaults with a borrower, the higher the insurance policy will be.
Alongside that initial risk assessment, the cost of the property, the necessary deposit and the insurer will likely affect the final price of the LMI.
In the current property market, for a $700,000 property, home buyers can expect to pay an LMI of approximately $28,000.
What Are the Benefits of LMI?
Although the idea of having to pay an additional insurance cost before you even move into your house isn’t ideal, there are some advantages if you are on your journey to get your own home.
These may not always be clear cut, but here’s a brief summary regarding the benefits that you can expect:
Earlier Access to Homeownership: It can be a struggle to save enough money for a house deposit and enter into the homeownership space. Whether it’s a rejected home loan application or simply finding a lender who will loan them the money they need, the hardships are evident.
LMI helps more homebuyers access homeownership. Those with lower income or a higher risk when borrowing can send in their applications and become one step closer to owning a home, with the LMI guaranteeing that the home loan and deposit will be covered.
Minimise Financial Risks: As said before, there are recurring risks between a borrower and a lender where the latter party would end up with a loss on their shoulders. LMI can help to minimise these risks and create a mutually beneficial outcome.
Potentially Lower Loan Cost: LMI allows more homeowners to borrow money from the bank without having to pay extra on top of their loan (for high interest rates etc.). Without LMI, a lot of homeowners would not be able to borrow as much money as they would otherwise be able to with LMI.
What Are the Disadvantages of LMI?
So with many positive benefits comes disadvantages as well. Here are a few points on why LMI may be disadvantageous to you as a borrower:
- Having to Pay Extra: An extra expense on the borrower;s side isn’t ideal. LMI can be hard to shoulder, especially in consideration of other home loan costs.
Does LMI have to be paid upfront?
Yes, LMI cannot be included as part of your loan. You will need to pay LMI as an upfront cost.
- Changing LMI Rates: The costs of LMI aren’t set in stone for each mortgage borrower and the amount can be hard to estimate which means it is hard to save for. It’s rather similar to stamp duty, wherein the amount depends on a number of factors including your borrowing amount, your deposit amount, plus it can be affected by your financial situation.
- Non-Transferrable Clauses: When it comes to LMI terms, the fee is often non-transferrable. This can often constrain you in your current home loan, eliminating any options of refinancing or terminating.
How Can You Reduce Your LMI?
Most borrowers may not be able to accommodate paying for LMI, especially a very high LMI cost.
However, there are several ways to reduce the cost of an LMI to make it more affordable. These techniques can also help in avoiding having to pay LMI altogether. Here are some methods borrowers can use to lessen their LMI costs:
Grow Your Deposit: LMI is used with home loan deposits that are less than 20%. By keeping that condition in mind, one way of reducing or avoiding your LMI is to have a bigger deposit compared to before.
How favourable this is will solely depend on your financial circumstances. Having a bigger deposit means needing a higher initial payment which can take a lot longer to save.
Find a Good Guarantor: LMI’s purpose is to be a guarantee that the loan will be paid properly. If the idea of getting insurance policies involved with your transaction isn’t ideal for your situation, find a different way – or person – to guarantee your home loan payment.
Picking out a guarantor is not an easy task for any borrower, though. You can choose a close friend or family, but keep in mind that they risk a lot if you ever decide to default on the home loan agreement you had with a lender.
Speak With Lenders: Choosing your lender is key to arranging the terms and LMI involved with the home loan you hope to take out. Some lenders may provide discounted or waived LMI costs at certain times, which can be quite an attractive option.
If there doesn’t seem to be any of those discounts available, try to check the LMI quotes that a lender may have for you. Each lender may have a different price, and it’d be better to go with the quote that seems the most manageable.
Can The First Home Super Saver Scheme Reduce Your LMI?
First home buyers in Australia who are struggling to save for LMI may want to look into the First Home Super Saver Scheme. This government-introduced scheme essentially allows you to save for your deposit through your superannuation fund.
By using the FHSS scheme, you can take advantage of having a tax efficient way to save for your deposit. Plus, if you’re someone who struggles with saving, this may be a good option for you to help you avoid taking out any of your home deposit savings.
Should You Pay LMI Or Save For a Bigger House Deposit?
Whether or not you should pay LMI or save for a bigger house deposit depends on your circumstances.
For example, if house prices are rising rapidly, it may be worth paying LMI as by the time you save enough for a house deposit, you may have been able to save costs by paying the LMI.
For many first home buyers, it can feel like you’re constantly “chasing” the 20% house deposit. But with LMI, you can enter home ownership earlier and this option may be a better financial opportunity.
However, if your LMI cost is very high, you may be better off to save up to 20% and avoid having to pay lenders mortgage insurance.
Understanding what an LMI is and what it entails can be quite eye-opening, as you can see all the possibilities laid out for you. It can be tough to make a final choice regarding how you’ll handle your home loan deposit, but making a decision should bring you a financial step closer to your dream home.
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