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Lenders mortgage insurance (LMI) explained

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?

Lenders mortgage insurance (LMI) protects your lender in the event you can’t make your mortgage repayments – it’s an insurance policy that protects the lender from financial loss.

With the ability to pass on shortfall risk to the insurance company, lenders are more willing to accept a lower deposit. protect umbrella portfolio saving money coin insurance rainy day

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. 

investor-enquiry-form

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
$300,000 $7,367 $3,752 $2,162
$400,000 $12,852 $6,474 $3,613
$500,000 $16,065 $8,092 $4,516
$600,000 $25,918 $12,304 $6,722
$700,000 $30,238 $14,355 $7,842

Quotes taken from Genworth LMI calculator, correct as at 1/1/2015

Reverse mortgage

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.

Off-the-plan purchases

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.offplan

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 land

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 approvcalculateal 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.

Refinancingrefinance

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. calculator coin money save debt

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. lending-money

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.lmi-vs-mpi

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
property.

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? questions

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.

 



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About

Andrew is a leading finance strategist who holds a Diploma of Financial Planning (Financial Services). With over 27 years of experience in finance, Andrew has been acknowledged by the mortgage industry with multiple awards.Visit www.intuitivefinance.com.au


'Lenders mortgage insurance (LMI) explained' have 1 comment

  1. Avatar for Property Update

    May 8, 2018 @ 9:40 am Graham

    Providers of LMI will not provide any information regarding the insurance contact or a pds so I have submitted the following to the Banking Enquiry …perhaps you or your readers would like to comment .

    Question submitted to the BANK enquiry re LMI
    Questions to the BANKS regarding Lenders Mortgage insurance and negatively geared property investments .

    Q1: The equity in the family home is taken into account when a loan is provided to purchase an
    investment property ? Yes / No ?

    Q2 : Would it be reasonable to assume that often the existing loan over the family home is
    refinanced at the time of providing additional funds to purchase the investment property .?

    Q3: The purpose of the refinancing is to apply the maximum possible proportion of the total loan
    to the investment property in order that the operational losses of the investment property may
    be claimed as a deduction against wages income to minimise personal taxation.
    That is to say the property is negatively geared (loss making ) and if funds cannot be input by
    the family, which is also committed to paying the monthly mortgage payments on the family
    home, the loan will fall into arrears. This situation may well arise as the result of a family
    crisis such as injury , sickness , redundancy or even the death of one party .Although the
    combined value of the loan over both the investment property and the family home may not
    exceed the benchmark of 80% LVR the bank will require Lenders Mortgage
    Insurance to guarantee repayment of any shortfall of funds as the bank is well aware of the
    increased risks of investing in a loss making venture that may well impact on the ability of
    the family to repay the mortgage.
    It is pertinent to note that the bank will advise the family that Lenders Mortgage Insurance
    will be required as the proportion of the loan allocated to the investment property ( the most
    at risk ) exceeds 80 % LVR .
    It is clear that the Lenders Mortgage Insurance is to cover the potential risk of any shortfall in
    the ability of the proceeds of the sale to repay to the bank the portion of the loan assigned to
    the investment property. That is the structure of the overall loan is designed to maximise the
    savings in personal income tax and shift the larger proportion of the loan ( in excess of the
    benchmark LVR Ratio ) to the loss making investment property and as explained the loss
    making nature of the investment increases the banks desire to cover this added potential risk
    with Lenders Mortgage Insurance.
    The Lenders Mortgage Insurance covers any potential shortfall in the ability of the proceeds
    of the sale of the investment property to repay the bank loan in full.
    The shortfall cannot be transferred and added to the loan on the family home as the Lenders
    Mortgage Insurance clearly covers the higher risk loan allocated to the investment property.
    To transfer the loan shortfall as explained in the following example would highly likely
    extinguish any potential loss covered by the Lenders Mortgage Insurance . That is the
    insurance company and the banks have colluded to extinguish any potential loss as a result of
    the forced sale of a high risk investment loan. Further the family has gifted the funds to the
    bank to pay for an insurance policy that is illegal as a premium is paid for a risk that does not
    exist and further the bank receives a commission for payment of the premium .

    These matters also give rise to questions regarding taxation and the insurance risk being taken
    by the bank itself or a subsidiary of the bank rather than letting the insurance contract to an
    independent third party insurance company such as QBE.

    TRANSFER OF LOSS ON THE SALE OF AN INVESTMENT PROPERTY

    As the following explains the loss on the sale of an investment property cannot be transferred
    to the family home

    EXAMPLE :

    Family home before refinancing : loan balance $170,000 Asset value $500,000

    Proposed Investment property loan required $320,000 Asset value $350,000

    The family will provide $30,000 from savings .

    LOAN AFTER REFINANCING :

    Total loan = $490,000 plus Lenders mortgage insurance $10,000 = $500,000

    Lenders Mortgage insurance of $10,000 will be added to the investment property loan

    Family home : loan balance $160,000 Asset value $500,000

    Investment property : loan balance $340,000 Asset value $350,000

    Total loan required $500,000 Asset value $850,000

    It is proposed that a loan of $500.000 will be provided allocated $160,000 loan against the
    family home and $340.000 against the investment property .
    That is the $330,000 equity in the family home has been used to secure the loan for the
    investment property.

    Q4: Although the combined loans of $500,000 has an LVR Ratio of 60% is it true to say the
    BANK would require Lenders Mortgage Insurance to cover :

    A : the loan of $340,000 over the investment property ? ( LVR Ratio 98% )
    OR
    B: the combined loan of $500,000 ? ( LVR Ratio 60% ) That insurance covering
    the risk of a shortfall in funds to repay the outstanding loan to the bank as a result of the sale
    of the investment property and the family home.

    It needs to be established whether the recipient of the loan is paying the premium
    for risk A or risk B . This is particularly important as if the insurance premium is based on a
    loan of $500,000 that is incorrect and the premium is falsely inflated .In the following
    example the lender intends to extinguishing the risk by transferring any loss on the sale of the
    investment property to the loan on the family home in the knowledge that the loss transferred
    would not raise the LVR Ratio of the family home to anywhere near the benchmark of 80%
    LVR ratio before Lenders mortgage insurance is required.

    EXAMPLE

    The breadwinner of the family suffers an injury and losses his/her job. As a
    result the family can no longer make contributions to cover the losses sustained by the
    investment property . The banks require the investment property be sold however the sale of
    the property falls short of the outstanding loan by $40,000 which is covered by Lenders
    mortgage insurance funded by a fee included in the loan to the mortgagee.

    Q5 The bank provides a total loan of $500,000 allocated $160,000 to the family home and
    $340,000 to the loss making investment property.
    By tying the proportions of the loan allocated to each property together the Bank is
    proposing that the loss ( in my example $40,000 ) be transferred to the loan over the family
    home. That is the loan allocated to the family home will increase by $40,000 thereby
    extinguishing the risk covered by the Lenders Mortgage Insurance.
    Not only will the risk of loss on the sale of the investment property be extinguished but
    my example makes it clear that if the loss of $40,000 is transferred to the family home the
    mortgage on the family home will increase from $160,000 to $200,000 ( 40% LVR Ratio )
    Well below the benchmark of 80% LVR being reached before Lenders Mortgage Insurance
    is required. Any reasonable person would accept that it is highly unlikely that the value of
    the family home would decrease by 60% and as such it is highly unlikely that the Banks
    would not recover their loan in full should the property need to be sold. That is the transfer
    of the loss to the family home has extinguished the risk covered by the Lenders Mortgage
    Insurance
    The banks arrangement to transfer any losses from the investment property to the
    family home is illegal based on the fact that the bank has charged a fee and received a
    commission for the establishment of an insurance to cover a risk that is extinguished when
    losses on one property are transferred to another .
    It is clear that the risk taken by the insurance company for the premium charged cannot be
    extinguished by transferring of losses by the bank.

    If the $40,000 loss was increased considerably ( for example the property had been
    downgraded by the tenants ) to say $150,000 .That would see the loan on the family home
    increased to $310,000 for a property valued at $500,000 ( LVR Ratio 52%)
    Hardly a risk to the bank . It would require the transfer of losses of $240,000 before the
    benchmark LVR Ratio reached 80% requiring LMI Insurance.
    That is conclusive : The risk covered by the LMI insurance cannot be extinguished by the
    transfer of losses from one loan to another .

    It is my opinion that the insurance company must be instructed to compensate the bank for
    any losses incurred on the sale of the investment property as the risk contracted for cannot
    be extinguished by the transfer of losses to the mortgage over the family home.

    Reply


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