Lenders Mortgage Insurance (LMI) is an important concept to understand when applying for a home loan, especially for those with a smaller deposit. A type of insurance that protects the lender in the event the borrower defaults on their home loan repayments. Typically, it’s required when a borrower has a deposit of less than 20% of the property’s value. This translates to a Loan to Value Ratio (LVR) of more than 80%.
Understanding how LMI works, how it’s calculated, and its impact on borrowers is essential when taking out a mortgage.
How Lenders Mortgage Insurance is Calculated
LMI is calculated based on several factors, including the size of your deposit, the property value, and the loan amount. The higher your LVR (i.e., the smaller your deposit), the higher the LMI premium will be. As a rule, if your deposit is below 20% of the property’s value, you’ll likely need to pay LMI. A one-time payment, typically added to your loan amount. Adding LMI to your loan, will mean paying interest on it over the life of your loan. The premium can vary depending on your lender and specific loan details. There are various LMI premium calculators available online, or your mortgage broker can provide an estimate based on your specific circumstances.
Who Does Lenders Mortgage Insurance Cover?
It’s essential to understand that LMI is not designed to protect you, the borrower; rather, it protects the lender. In the event you’re unable to make your loan repayments and default on your mortgage, the lender may recover their losses through LMI. Especially important for lenders when dealing with high-LVR loans because a smaller deposit means they take on a higher risk in case of market fluctuations or financial difficulties experienced by the borrower.
It’s purely for the lender’s protection. As a borrower, if you default, you may still face the consequences, such as legal action, repossession of the property & negative credit score. The insurance does not safeguard you from these outcomes.
Impact on the Borrower
While LMI can add to the overall cost of purchasing a property, it also provides a benefit to borrowers. By allowing home buyers to access the property market with a smaller deposit, LMI enables borrowers to potentially buy a home sooner than they would if they had to save up a full 20% deposit. LMI can also be a strategy used by investors. Specially, those who plan on building equity in their property and happy to pay the insurance to preserve cash reserves.
The key impact of LMI is the added cost. Whether you pay it upfront or roll it into your loan, LMI increases the total amount you’ll need to borrow. This means you’ll end up paying more in interest over the life of your loan. Understanding this cost is critical when planning your finances for a home purchase.
Loan to Value Ratio and LMI
The Loan to Value Ratio (LVR) is a percentage that represents the amount of your loan compared to the value of the property you’re purchasing. LMI generally kicks in when the LVR exceeds 80%, meaning you have less than a 20% deposit.
For example, if you’re buying a home valued at $1,000,000, a 20% deposit would be $200,000. If you have less than that saved, say $100,000 (or a 10% deposit), the LVR would be 90%, and LMI would apply. The higher the LVR, the higher the LMI premium.
Conclusion
Lenders Mortgage Insurance can significantly affect your overall borrowing costs. It also provides an opportunity to enter the property market with a lower deposit. While LMI protects the lender, it’s essential to factor in how it impacts your loan repayments and overall financial planning. Working with a mortgage broker like Roar Capital can help you understand your LMI obligations, calculate the costs, and explore ways to reduce your LVR to avoid paying LMI altogether.
