LMI – Mortgage Lenders Insurance FAQ 2023
If you’re a first home buyer, or you’ve started shopping around for a new home or investment loan, you’ve probably heard of Lenders Mortgage Insurance or LMI for short.
We’ve put together this article to explain what Lenders Mortgage Insurance is, when it comes into play, along with important facts about LMI you may not already know.
1: What Is LMI?
LMI is a type of insurance your lender will usually charge you for if your loan amount is more than 80% of the property’s value; that is, you have less than a 20% deposit of your own to contribute towards the purchase.
This applies to both Home Loan and Investment Property Loans.
For example, if you want to purchase a unit worth $500,000 and have saved up $50,000 (or 10% of the value) to contribute towards the purchase, you will need a loan of $450,000 to complete the purchase. This represents a loan of 90% of the property value, also known as a loan-to-value ratio (LVR) of 90%.
In this situation, you would normally need to pay LMI as you are not contributing a deposit of at least 20%.
Why Do You Have to Pay LMI?
Lenders require you to pay for LMI when you borrow more than 80% of the property value (i.e. an LVR of above 80%) to help reduce some of the risks of borrowing an amount close to the total property value.
This is because lenders consider higher LVRs much riskier than lower LVRs.
What Does a Low LVR Mean?
A low LVR means the property is worth significantly more than the total amount of the loan.
If a borrower with a low LVR is unable to make their scheduled repayments and needs to sell the property as they can no longer afford it, or if the property has to be repossessed and sold by the lender, there is a very good chance the lender will be able to recover all the money owed to them.
What Does a High LVR Mean?
A high LVR means the loan amount owing is very close to the total value of the property.
If the LVR is too high and the total loan amount is too close to the total value of the property, there is a risk that the bank may not be able to recover all the money owed to them if the property needs to be sold at a loss, especially if house prices slump.
Borrowing Capacity and Lenders Mortgage Insurance
Paying LMI does NOT increase the amount you can afford to borrow, known as your borrowing capacity. Your borrowing capacity is determined using several factors, including your income, expenses, liabilities, and the loan interest rate you are applying for, plus an additional buffer in case rates increase.
As a rough guide, if your borrowing capacity is $450,0000 and you have a deposit of $50,000 plus extra to cover associated expenses, your maximum purchase price will be $500,000 (i.e. the loan amount plus deposit amount).
If you only have a $25,000 deposit, your borrowing capacity remain the same, so your maximum purchase price will only be $475,000, and so on.
The smaller your deposit, the less you can pay for a property overall.
2: How Much Does LMI Cost?
If you have a 20% deposit plus enough to cover any associated costs such as legal and conveyancing costs, loan fees, moving expenses, and stamp duty (if applicable), or you are eligible for any of the exceptions listed in section 9 below, you generally won’t need to pay any LMI.
What Factors Is LMI Based On?
If you do need to pay LMI, it’s important to know that the cost is based on several factors, including:
- the size of the total loan you need
- the size of your deposit
- the value of the property
- the purpose of the loan (i.e. whether it is for an owner-occupied or investment property)
- the loan term (e.g. whether it is a standard 30-year loan or otherwise)
- the LMI insurer used by your lender.
The larger your loan and the smaller your deposit, the higher your LMI premium will likely be.
Sydney First Home Buyers and LMI
LMI can cost anywhere from a few thousand to tens of thousands of dollars for a typical Sydney first home buyer with a small deposit. For example, a non-first home buyer purchasing an owner-occupied property worth $800,000 with a 10% deposit of $80,000 could expect to pay just under $20,000 in LMI.
Your Finance Broker Can Help You Understand and Calculate LMI
Your finance broker will advise you early in the loan process how much LMI you can expect to pay, and they will work with you to find a way to reduce this amount if possible.
3: The Lender Will Use Their Own Property Valuation to Calculate LMI
Lenders will use their own valuation, conducted by a firm of property valuers, when deciding on the overall value of your property and how much they are prepared to lend against it.
This means that if a real estate agent says your house could sell for $500,000 or you have agreed to pay a $500,000 purchase price to buy a new property, it’s not always a safe bet that the bank will automatically lend you $400,000 without LMI (assuming you can afford to borrow this much in the first place).
Bank Valuations Vs Market Value in Australia
Bank valuations are often more conservative than the ‘market value’ that could be achieved by a real estate agent, which means that lender valuations can sometimes come in at less than expected.
LMI and Bank Valuations
To avoid the risk of bank valuations coming in too low, resulting in the need for you to pay extra LMI, your finance broker will usually order an upfront valuation with your preferred lender before proceeding with any loan application.
It’s important to note that some lenders will only provide an upfront estimate based on general property data and will not send a valuer to physically inspect the property until later in the process. This does not entirely eliminate the risk of a lower valuation being returned.
Your Finance Broker Can Help and Advise About LMI
If you need to borrow close to the 80% mark and there is a risk you may be liable for LMI, your finance broker will talk you through your options upfront to mitigate this risk as much as possible.
4: LMI Doesn’t Protect the Borrower; It Only Protects the Lender
Since LMI is a type of insurance that the borrower has paid for, many borrowers mistakenly believe it provides them with some protection if they cannot meet their home loan repayment obligations.
However, unfortunately, this is not the case.
Understanding LMI Insurance, What it Protects, and Whom It Protects
In simple terms, LMI is a type of insurance that only protects the lender if the borrower cannot repay the loan and the property is sold for less than the amount still owing on the loan. In this case, the insurer will pay the difference to the lender to ensure they are not out of pocket; nothing is paid to the borrower.
The benefit of LMI to the borrower is simply allowing them to enter the property market sooner than possible if they’d had to save up a full 20% deposit.
It is important to note that while LMI does not protect borrowers, some other types of insurance may protect borrowers in the event they are unable to meet their repayment obligations. For many Australians, a home loan is the most significant debt they will ever take on, and it’s important to consider whether you should take action to guard against the risk of having to sell your home due to unforeseen events such as unemployment, illness, injury or the death of a co-borrower.
Although this is outside the scope of a finance broker, you should be offered the opportunity to speak with a qualified expert about the personal insurance options available during the loan process.
5: LMI Can Come as a Surprise If You Have Overestimated Your Deposit
It’s no secret that buying a home or investment property is expensive. Despite a recent decline in property values in many areas, property prices, on the whole, remain high, making it harder and harder for most people to save up a full 20% deposit
In January 2023, the median price of a home in Sydney across all dwelling types sat at $999,278. It’s safe to say that not many people – particularly first-home buyers – have a spare $200,000 lying around to chip in towards a purchase.
Unfortunately, the costs don’t stop there.
Costs Related to Mortgages and How You Can Underestimate How Much Money You Have Available for a Deposit
Moving costs, stamp duty, legal costs, loan fees and other hidden costs must be factored into the funds available for purchasing a property (also known as your overall funding position).
In our experience, many people tend to underestimate these costs and overestimate the amount of money they will have available to use towards their deposit.
This often means that people end up paying LMI because other costs eat up some of their 20% deposit, and they, therefore, need to borrow more than 80% to cover the shortfall.
For this reason, it is very important to factor in all the expected costs upfront to ensure a realistic picture of how much you can contribute towards a deposit.
Your Finance Broker Can Help You Understand your Financial Position
Your finance broker will take the time to understand your overall financial position and help you calculate the costs you are likely to incur, and will provide you with a written overview of your funding position upfront to reduce the risk of any nasty LMI surprises.
6: LMI Can Be a Good Option in Many Situations
Avoiding the cost of LMI is ideal, as it ultimately means more money in your pocket.
The larger the deposit you can save, the less you need to borrow, meaning your repayments are smaller, and you have more equity in the property from the beginning. However, for many Australians, the reality is that saving a 20% deposit is just out of reach, especially in a high-cost-of-living environment.
When You May Pay a Premium for LMI and Why
Sometimes, paying an LMI premium to enter the property market sooner makes sense.
- you may have your eye on a particular property and need to move quickly to acquire it
- you would ultimately pay more in rent or board in the time it would take you to save up the remaining deposit than you would lose LMI by buying sooner
- you can start building up property equity sooner by buying now instead of waiting.
Your finance broker will take the time to fully understand your financial situation and provide you with a range of calculations to help you decide whether paying LMI is a good option or whether it might be in your best interests to wait a little longer to save up a larger deposit.
7: You May Not Need to Pay LMI Upfront on Your Loan
Most lenders will allow you to ‘capitalise’ your LMI.
This means they add your LMI costs to the amount you borrow and the amount you require for the property purchase, so you don’t need to come up with a single lump sum payment upfront. This amount is built into your repayment amounts, so you repay the LMI as you repay the loan.
This can be helpful if you don’t have enough surplus cash to pay a lump sum amount all at once, and it allows you to retain more of your funds towards extra costs. However, it’s important to realise you will pay more overall if you choose this option, as you will be charged interest on the total loan amount, including the LMI portion of the loan.
Your repayments will also be higher as you are borrowing more overall.
You will also need to demonstrate that you can afford to pay back the entire loan, including the LMI portion; your overall borrowing capacity must be high enough to prove you can afford this option.
Capitalising LMI and Borrowing Capacity
Capitalising LMI can reduce your borrowing capacity overall as some of your income must be redirected away from paying off the loan principal.
More will go towards paying the LMI premium and accrued interest.
8: It Is Possible to End Up Paying LMI More Than Once on Your Loan
A common misconception is that you only need to pay LMI once when buying a first property. However, paying LMI more than once on the same property is entirely possible.
This happens most commonly when people try to refinance their loan before the loan size falls below 80% of the property value.
For example, imagine you bought a unit for $500,000 and borrowed $450,000 (90%) because you could only contribute a deposit of $50,000 (10%).
After two years of scrimping and saving to make extra repayments to your loan, you now owe $430,000, and the property value has increased to $520,000. You are now sitting at an LVR of around 82.7% – just above that magical 80% mark that allows you to dodge LMI.
If you decide to refinance at this point, you would likely need to pay a small amount of LMI again, as you have less than 20% of the equity in the property. This is why refinancing is generally uncommon until you hit the 80% mark.
When You May Have to Pay LMI More Than Once on Your Loan
In some cases, it can be worthwhile paying LMI again. If the new lender has a substantially lower interest rate than your current lender, you may end up saving more in interest by moving than you would lose in LMI costs.
Your finance broker will provide you with calculations to demonstrate the impact of refinancing sooner vs waiting until you are under the 80% mark, and they will talk you through the pros and cons of each situation.
LMI The Impact of ‘Topping Up’ Your Loan
Likewise, you may need to pay LMI again if you make changes to the loan that put you back over the 80% mark, even if you previously sat below it.
For example, sometimes people ‘top up’ their loan e.g. to increase the loan amount to renovate their property, or consolidate other debt into their home loan.
Once again, if this course of action will take you over the 80% mark, your broker will help you understand the impact of doing so and help you compare your overall financial position if you proceed vs waiting.
Can You Get a Refund on LMI You Have Already Paid on Your Loan?
If you are considering a course of action that would result in you paying LMI more than once, you may wonder whether you can get a refund on the initial LMI you paid.
A few lenders and insurers may be willing to consider a full or partial LMI refund in exceptional circumstances (such as where the loan is paid off or substantially paid down very quickly).
Unfortunately, however, in most cases, LMI premiums are non-refundable. They are also not transferable between lenders, so if you refinance to a new lender over the 80% mark, you may be required to pay again.
Your finance broker will be able to assist you in understanding each lender’s policy around LMI refunds. It is unlikely that your lender will automatically issue a refund, even if you are eligible for one, so it pays to speak to your broker about whether this is something you should pursue.
9: How to Avoid Paying LMI on Your Loan
The surest way to avoid paying LMI is to have a deposit of at least 20% plus enough to cover any associated costs, such as legal and conveyancing costs, loan fees, moving expenses and stamp duty (if applicable).
5 Options to Help Avoid LMI on Your Loan
may be ablSometimes, there may be options to avoid paying LMI even if you don’t have a 20% deposit.
1. A few lenders offer loans of up to 85% without LMI (or with only a tiny amount of LMI) for first-home buyers.
This means you only require a 15% deposit instead of the total 20% deposit that would typically be required.
2. Some lenders offer loans of up to 90% without LMI for eligible home buyers based on their profession.
These offers usually apply to high-income industries such as medical, legal, financial or allied health professionals or niche industries such as professional athletes, entertainment professionals or other industry specialists. Only a few lenders offer these waivers and generally, you must earn a high income to qualify.
3. Several state and federal schemes are currently on offer to assist eligible first-home buyers, single parents, and regional buyers into a home with a deposit of 2% to 5%, depending on the scheme, without needing to pay LMI.
Strict eligibility criteria and a limited number of places apply for each scheme.
4. If you own other properties, equity from these properties can be used instead of a cash deposit.
To do this, you need substantial equity in your existing properties (you owe much less than the property’s value). The total amount you owe across all your properties must be equal to or less than 80% of the value of all your properties combined. Otherwise, you will generally pay LMI.
5. If you are a first-home buyer, you may be able to use a guarantor. This means that equity from an eligible family member’s property can be used instead of a deposit for your property.
For this to be an option, the guarantor (usually a parent) has to be in a solid financial position and have sufficient equity in their home, so any existing loan plus the deposit for your new property does not exceed the 80% mark. Being a guarantor can be risky, so your finance broker will ensure all parties understand the risks and benefits.
Your finance broker will be able to talk you through these options, check your eligibility for any schemes or waivers, and help you compare various scenarios based on your individual circumstances.
10: LMI Does Not Allow You to Entirely Avoid Paying a Deposit
LMI can help you get into a property without a full 20% deposit, but it doesn’t completely do away with the need for a deposit.
There are no 100% loans in Australia anymore, so you will still need to contribute some of your own money towards a property purchase (unless you have sufficient equity in other properties you own instead of a cash deposit or you are using a guarantor, as discussed above).
Some lenders prefer a deposit of 10% or more plus expenses and will only lend up to 90%. However, many will consider lending up to 95% of the property value (including capitalised LMI if applicable) if you have saved up a deposit of at least 5% plus expenses.
What Is the Minimum Deposit Required in Australia When Applying for a Home Loan or Investment Loan?
In some circumstances, such as some of the schemes mentioned above, it may be possible to borrow up to 98% of the property value (98% LVR), meaning you only need to provide a 2% deposit.
However, it’s important to note that only some types of home buyers are eligible for these schemes, and places are extremely limited even if you are eligible. You will still need to cover any additional costs out of your pocket.
A very small handful of lenders will also allow you to capitalise LMI costs up to a total loan size of 98% LVR. This is essentially a 95% loan towards the property price plus up to 3% LMI added to the amount you borrow. Again, you will need to cover any additional costs out of pocket.
However, it is essential to remember that these options are not available to all borrowers, and most people will require a deposit of substantially more than this
Speaking to your finance broker early in the property buying process is important to understand your options and set a deposit goal appropriate to your circumstances.
So, WHAT’S NEXT?
When you engage a finance broker to find you a great home or investment loan deal, he or she will take the time to understand your situation and let you know whether LMI is likely to come into play, whether it can be avoided, and how it will impact you and your finances.
The role of a finance broker is to educate and support you through the entire loan process and ensure you understand what is happening every step of the way, whether you are an experienced investor or a first-home buyer with no background knowledge of the loan process. Therefore, there is no need to be embarrassed if you don’t know the ins and outs and what to expect before speaking with a finance broker.
Whether you are feeling bamboozled by bank jargon, want to find out whether you are in a position to purchase a property or refinance an existing loan, or simply want to chat about your options, the team at NBS Home Loans is here to help.
NBS Home Loans has written a helpful article for Australians on the 5 Signs That Tell You It’s Time To Review Your Home Loans in 2023: 5 SIGNS THAT TELL YOU IT’S TIME TO REVIEW YOUR HOME LOAN IN 2023
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