Understanding Lenders Mortgage Insurance and Ways to Avoid It
Buying a home is a significant milestone for many Australians, but it often comes with financial hurdles, especially when it comes to securing a mortgage. One of the challenges borrowers may face is the requirement to pay Lenders Mortgage Insurance (LMI). In this blog post, we'll delve into what Lenders Mortgage Insurance is, explore some strategies to avoid paying it and why in some cases it may be a good thing.
What is Lenders Mortgage Insurance (LMI)?
Lenders Mortgage Insurance is a type of insurance that protects lenders in the event that a borrower defaults on their home loan and the sale of the property doesn't cover the outstanding mortgage balance. It's important to remember that LMI does not protect borrowers, rather, it provides a safeguard for lenders against potential losses. So, in essence you are paying the lenders insurance policy premium for them.
Why is LMI Necessary?
Lenders Mortgage Insurance is typically required by lenders when a borrower has a deposit of less than 20% of the property's purchase price, and the Loan to Value Ratio (LVR) exceeds 80%. This is because a smaller deposit increases the lender's risk, as there's less equity in the property to cover potential losses in case of default. However, in the eyes of a lender not all property is treated equal, different properties my have different LVR restrictions. Certain property types or post codes may be deemed more ‘high risk’ and a lender may only allow a maximum LVR of 70%, or in some cases even less. Which is why it is important to discuss what type of property you’re looking to buy and where it is located with your broker before making an offer.
Ways to Avoid Paying LMI:
Save for a Larger Deposit: This may be obvious… but the most effective ways to avoid paying LMI is to save for a larger deposit. By aiming for a deposit of at least 20% (plus extra for stamp duty and fees) of the property's purchase price, borrowers can bypass the need for LMI altogether. While saving a larger deposit may take time and discipline, it can ultimately save borrowers thousands of dollars in insurance premiums.
Guarantees: Some lenders offer the option of a family/parental guarantee, where a family member, in most cases a parent, uses their own property as security for a portion of the borrowers home loan. This can help borrowers secure a mortgage with a smaller deposits (or even no deposit) and avoid paying LMI. The biggest advantage from a family guarantee is that the borrower does not have to provide a deposit and some lenders will even allow the applicant to borrow up to 107% of the purchase price to finance in stamp duty and other purchase fees. As a guarantor (family member providing the additional security) is it important to know your obligations, most lenders will suggest that you seek advise from a legal professional before signing the guarantor documents. We will deep dive the topic of guarantees in its own blog post at a later date.
Government Schemes: The First Home Guarantee (FHBG) is part of the Home Guarantee Scheme (HGS), an Australian Government initiative to support eligible home buyers to buy a home sooner. This enables an eligible home buyer to buy a home with as little as 5% deposit without paying Lenders Mortgage Insurance. (Housing Australia, 2024). To apply for the FHBG, home buyers must meet certain eligibility requirements. To find if you are eligible the best person to speak to is your mortgage broker.
Eligible professions: Professions that may be eligible for an LMI waiver include medical practitioners, nurses, legal professionals, accountants, finance professionals, entertainment industry workers, professional athletes, and mining specialists. Medical professionals who are members of professional organisations like the Australian Medical Association may qualify for an LMI waiver for loans up to a certain amount. Legal professionals also qualify if they meet certain income criteria. Similarly, finance professionals need to demonstrate membership in relevant professional bodies and meet income requirements. Entertainment industry professionals represented by accredited managers or agents can also have LMI waived under specific conditions. Professional athletes and mining specialists must meet income thresholds and other criteria to qualify.
If you can’t avoid LMI, in most cases it’s best to pay it.
Why might paying LMI be the best thing you ever do to enter the property market?
Imagine you're eyeing off a $500k house, aiming to borrow 80% to avoid LMI. That means you need $100k for a deposit, plus extras for stamp duty and fees. Let's say you've saved $25k, a five-year endeavour, and it'll take another 15 years to hit that $100k mark. But here's the catch: that $500k house from 15 years ago? It's now worth $1m. And now you need a $200k deposit… This is why waiting and saving may not cut it. Had you paid the LMI premium initially, you'd now own an asset worth $1m, with over half a million dollars in equity.
Theres no doubt when it comes to purchasing a home one of the biggest barriers of entry is the deposit. Especially today with cost of living pressures being so high the cash left over after expenses each month is reducing, only increasing this barrier. However, saving for a deposit isn't impossible. With effective budgeting, prudent spending habits, and leveraging LMI, owning your first home becomes more than just achievable it becomes a reality.
Conclusion.
Lenders Mortgage Insurance can add a significant cost to purchasing a home, especially for borrowers with a smaller deposit. However, by understanding what LMI is, why it's necessary, and exploring alternative strategies to avoid paying it, borrowers can make informed decisions and potentially save (or make) money in the long run. Whether it's saving for a larger deposit, leveraging government schemes, or negotiating with lenders, there are various avenues available to help borrowers navigate the home buying process with greater confidence.
