Are you motivated to get into the property market but haven’t had the time to save a suitable deposit?
Are you self-employed and struggle to prove to lenders you have a stable income?
If you answered yes to either of these questions, don’t be disheartened, you still have an opportunity to purchase that dream property.
Lenders mortgage insurance (LMI) can help you buy a property sooner but you must understand what it is, its benefits, pitfalls and how it’s calculated.
What is lenders mortgage insurance?
With the ability to pass on shortfall risk to the insurance company, lenders are more willing to accept a lower deposit.
So, by reducing the deposit required, borrowers can purchase a home much earlier.
The upside to this, of course, is you can buy a home without having saved the required 20 per cent deposit.
Realistically, in today’s market, paying LMI now could be cheaper than the extra dollars needed to secure a property in a year’s time if prices rise dramatically in that period of time.
If your loan is high risk – for example, if you’re taking out a large loan, more than 80 per cent of the property value or if you don’t have proof of income and employment history then you may be required to pay an LMI premium.
This will cover any of the loss to the lender if the property is ever sold at a loss.
When do you have to pay LMI?
You can pay LMI as a one off lump sum at the establishment of the loan or it can be capitalised onto the loan repayments, which is often the case for many buyers. LMI is generally paid at settlement with all other lender and government charges.
Let’s take a look at when LMI is a consideration for a variety of property purchases.
Standard Property Purchase
Usually you will pay LMI on your home loan if you are borrowing more than 80 per cent of the property value on a standard loan or more than 60 per cent of the property value on a low doc loan.
The danger with a 90 per cent home loan for a lender is that your monthly repayments and loan terms are higher than they would be if you had a 20 per cent deposit or more. For this reason, LMI is usually charged.
Low documentation loans are designed for the self-employed who don’t have the necessary documents required to get traditional home loans and usually carry higher interest rates and require LMI, which adds to the overall cost.
Loan to Value Ratio (LVR)
Loan to Value Ratio (LVR) is the proportion of money you borrow compared to the value of the property. The leftover money is your deposit.
|Cost of property||Cost of lenders mortgage insurance|
|5% deposit||10% deposit||15% deposit|
Quotes taken from Genworth LMI calculator, correct as at 1/1/2015
A reverse mortgage allows homeowners to access a lump sum or an annuity using their home as collateral.
It’s getting a loan against a property you already own, usually accessed by older home owners who have already paid off their home loans.
You wouldn’t usually be charged LMI on a reverse mortgage.
The benefit of reverse mortgages is that borrowers often continue to live in the property until they die or they can use the funds for aged care/accommodation/health services, etc.
LMI is often required when buying property off the plan.
There are many pitfalls of purchasing a property before it has been built as there are no guarantees the property you purchase will rise in value, in fact, quite often these valuations will come in lower than the purchase price thus exposing a client’s ability to fulfil the purchase.
Some of the reasons why this might happen are: – you have to pay for the developers margin to build, if the property was sold by a 3rd party, they are often paid fees (sometimes exorbitant) to complete a sale, if someone can’t complete a purchase there may be a “forced” sale that will affect the developments overall prices and there may also be a number of “like” developments about to complete thereby affecting the property’s overall value due to concentration risk.
A prime example of this is Melbourne Docklands apartments, “where buyers ended up paying more for their properties than they were worth, because real estate prices failed to appreciate during the construction period,” according to valuer Greville Pabst
In fact, we at Intuitive Finance believe that investors who purchased such properties may suffer short-term losses with the recent APRA changes affecting some buyer’s ability to settle on purchases.
This affects everyone’s values as often forced re-sales at lower than the purchase price can eventuate in order to clear the liability.
In turn, these reduced prices are often then used as the basis for ongoing valuations
Unregistered residential land is land that’s for sale where a certificate of title isn’t yet available.
New home builders are unable to start construction on these sites until the land is registered and council has provided a building approval for the individual lot.
If the mortgager/developer can’t proceed, substantial additional costs are usually incurred with another builder completing the works, plus inevitable additional holding costs, including interest on mortgages.
When the economy is weak, vacant land tends to fluctuate in value therefore banks are more conservative when approving a home loan.
The key for the lender is to ensure that moneys advanced are properly secured.
When the economy is weak, vacant land tends to fluctuate in value and may take longer to sell. This is particularly true in country areas and remote locations where land prices fluctuate more often.
Normal houses on the other hand tend to have more potential buyers and sell much faster. Banks are more conservative when approving a home loan for vacant land as a result of the higher volatility of land prices.
On a lease
The problem with leased property is you generally can’t borrow against it therefore most insurers won’t take the risk.
You will be required to pay LMI on a lease if borrowing more than 20 per cent. If you have to foreclose on a lease, the lenders can’t rely on your selling of the property to make up any shortfall because you don’t own the property.
It would be unusual to secure a loan on a leased property without LMI.
There are various reasons for refinancing – you may want to refinance to access a lower rate; for debt consolidation; have an opportunity to invest or you need to have increased education or home improvement funds.
If your circumstances have changed or if you’ve had your home loan for a few years, refinancing can offer you the chance to take advantage of more flexible features.
When refinancing your loan, not only is there no refund on the premium, regardless of how soon you refinance, you will have to pay it again if your loan is more than 80 per cent of the value of your home.
Even though the lender you originally placed your loan with is no longer at risk should you default, the lender that you refinance with isn’t covered.
The real problem for homeowners wanting to switch lenders, say from NAB to Westpac, is the potential double payment of LMI.
It generally isn’t possible to transfer your mortgage insurance if you switch lenders.
Top up Mortgage Insurance
If you have already paid mortgage insurance on your property, and then your property’s value has increased and you wish to use the equity you have gained in it for another purchase or reasons other than property, then you can increase your loan back to within the original LVR (Loan to value ratio) and simply pay a small top-up premium.
This is a very effective way to access equity within an original premium.
What does LMI actually cover?
LMI protects the lender against a home selling for less than the lender is owed.
The Mortgage insurance provider pays the shortfall to the lender to cover the loss, giving the lender peace of mind.
LMI means that even with a small deposit, you have the potential to own your home sooner, allowing the lender to have confidence in offering you a home loan, because it knows any losses will be covered.
With LMI in place, some lenders will allow you to borrow up to 95 per cent of the purchase price of your home.
How is LMI actually calculated?
Lenders mortgage insurance (LMI) is calculated as a percentage of the loan amount.
Your LMI will vary depending on your Loan to Value Ratio (LVR) as well as the amount of money you wish to borrow.
The percentage you are required to pay increases as the LVR and loan amount increase and usually goes up in stages.
Lenders mortgage insurance costs differ depending on the loan, lender and the LMI provider.
Some institutions will self-insure for deals up to a certain LVR. Get estimates as LMI can potentially differ by thousands of dollars between providers.
An example may be:
|88% LVR + LMI||90% LVR + LMI|
|Purchase Price: $500,000||Purchase Price: $500,000|
|Loan Amount: $440,000||Loan Amount: $450,000|
|LVR 88%||LVR 90%|
|LMI $5,755||LMI $9,911|
How to avoid paying lenders mortgage insurance
To avoid lenders mortgage insurance, a deposit of 20 per cent or more of the property purchase price is needed.
Ways to save the 20 per cent deposit required could include asking your parents to chip in, finding a higher paying or secondary job, or allowing yourself more time to grow your deposit.
Some borrowers can avoid paying lenders mortgage insurance by borrowing more than 80 per cent of a property’s purchase price.
This type of offer is only available to high quality, low risk borrowers, i.e. employed full-time in secure, long-term jobs with a stable housing history and evidence of genuine savings and no black marks against their credit file.
Does a family guarantee help me avoid paying lenders mortgage insurance?
Firstly, what is a family guarantee?
Well this is when a parent or close family member will actually lodge their home or property as equity support for a proposed purchase to help you avoid paying mortgage insurance.
This is very effective in helping first home buyers enter the market but can also be used for clients wishing to buy an investment property.
The obvious benefit for this is the avoidance of paying LMI, however it needs to be noted that the guarantor’s property is then linked to the transaction until such time as the property’s value has increased or the loan has decreased back to an LVR of 80%. Alternatively, to remove the guarantee, you may also then wish to pay LMI to remove this.
Lenders mortgage insurance (LMI) vs mortgage protection insurance (MPI)
Lenders mortgage insurance (LMI) covers your lender – the institution providing your loan – in the event you can’t make your repayments.
If the lender needs to foreclose on your loan, then LMI covers the lender for any losses once the property is sold.
Mortgage protection insurance (MPI) is a policy taken out to protect you if you are not able to make your mortgage repayments.
Policies are arranged to cover your mortgage repayments in case you lose your job or suffer a serious illness, injury or even death.
In some instances, mortgage protection insurance may be tax deductible, particularly if you are taking it out for an investment
We have a reliable, cost-effective insurance partner, so we can also help you organise an affordable mortgage protection insurance policy if you need one.
Frequently Asked Questions
I heard that home loans also need to be approved by the LMI Insurer. Is that true?
Applications for home loans that lenders deem high risk have to be approved by mortgage insurers. This is because the LMI provider is taking the risk from the lender. Conservative mortgage insurers require the borrower to have a credit history with no blemishes, a savings record and stable employment.
What do I do if my home loan has been rejected?
If your application for a home loan is rejected because of an LMI provider’s criteria, seek advice from your mortgage broker. You could apply for another home loan with a lender who self-insures or uses a different LMI provider.
How much can I borrow for an investment property?
How much you can borrow depends on your current financial status and is assessed on a number of factors including your income, savings, current financial commitments, credit history and living expenses.
What is a mortgage?
A mortgage is an agreement by which a person borrows money pledging a piece of property that he or she is buying as security.