If you’re looking at buying your first home, chances are you’ve heard the phrase ‘Lenders Mortgage Insurance’ thrown around, or maybe even the acronym ‘LMI’, but how many of us know exactly what this means?
If you’re anything like most first-time home buyers, you may be totally worried and even may be confused about this supposed extra cost towards buying a home, that only some people have to pay. You may be wondering who pays LMI, why they pay it and exactly what costs are involved.
If you’re new to the property investment world, don’t fret because we’re about to give you the low-down on everything you need to know about LMI, including what it is, how you can avoid it, and why you might need to pay it.
What is Lenders Mortgage Insurance (LMI)?
Lenders Mortgage Insurance is a form of insurance that is paid by the home loan owner but designed to protect the lender, just in case you default on your home loan and can no longer make your repayments.
The important thing to recognise is that not everyone pays for LMI. Usually, LMI is only required when the borrower is taking out a loan for 80% or more of the value of the property (meaning they do not have the ‘traditional’ 20% deposit). This percentage is otherwise known as the Loan-to-Valuation-Ratio or LVR, and in most cases, if your LVR is over 80%, you will most likely be required to pay for Lenders Mortgage Insurance.
An important distinction to make is that LMI is not there to cover you (or your guarantor), it simply exists to protect your credit provider in the event that you cannot pay back your loan.
What are the benefits of LMI for the borrower?
Despite looking very gloomy, Lenders Mortgage Insurance (LMI) does have some benefits for the borrower that make it well worth your consideration.
Firstly, it allows buyers to take out bigger home loans that would have otherwise been unavailable to them, giving those first home buyers who are trying to break into heavily-inflated property markets a fighting chance.
LMI also means that borrowers are able to buy a home sooner since they do not have to wait until that have the traditional 20% deposit. Depending on the market, as well the buyer’s personal circumstances, despite the extra cost associated with LMI, this could very well leave them better off in the long run.
Of course, whether LMI would be an advantage or disadvantage to you depends entirely on your personal situation. Whilst for some, there may be a benefit to forking out for LMI and entering the market a little soon, for others, it may be wiser to wait and save for a bigger deposit. To assess which camp you sit in, we suggest you carefully consider the market you are trying to buy into as well as your personal circumstances, and if possible, seek the advice of a financial advisor.
Does LMI need to be paid upfront?
Whilst LMI is a one-off payment, with most insurers there is usually some flexibility as to how it is paid.
The first way to pay for LMI is in a one-off, upfront payment. However, although for some people this is no problem, for many others this can be hard, considering that if they had a tonne of money sitting around, they would have been able to meet their minimum deposit in the first place (and avoided LMI altogether).
The second way to pay for LMI is to capitalise the payment into your mortgage. Capitalising LMI into your mortgage essentially means that the cost of LMI is added to your home loan, meaning that you pay it off in regular instalments just like you would with your normal home loan repayments.
How can I avoid paying Lenders Mortgage Insurance (LMI)?
In most cases, LMI can be avoided by having a deposit that is over 20% of the value of the home. This could mean saving for longer or deciding to buy in a more affordable location, where your deposit will have a bigger ‘kick’.
In some cases, having a guarantor can also allow you to borrow more and help you to avoid paying for LMI. This means having someone in your family, such as your parents, putting some of their house up as equity to help increase yours, effectively making your deposit worth more.
Working out whether or not you will need to pay for LMI, as well as working out strategies to avoid it, is dependent on your individual circumstances so it’s always better to check with your lender (or potential lender) as to whether you will need to pay for LMI.
Wondering whether you’ll be required to pay for Lenders Mortgage Insurance? Speaking to a broker at Finance Circle Group who can help you to assess your borrowing power and whether you’re eligible for a home loan without paying for LMI.
Finance Circle Group is not a property agent or financial advisers. This article is general and has not taken into account your objectives, financial situation, or needs. Consider whether any advice is right for you. You may need financial advice from a qualified adviser. Consider the product disclosure statement (PDS) before making any financial decision.