If you want to buy a home but are struggling to save up an adequate deposit, you may be able to borrow money from a lender. However, you will have to pay lenders mortgage insurance (LMI).
LMI is insurance that the lender takes out to protect itself if they are not able to recover the outstanding loan balance and there is a “shortfall”. This is when you are not able to keep up with your monthly loan repayments and the proceeds of the sale of your house are not enough to cover the amount you still owe to your lender.
It’s important to note that although you have to pay for it, LMI protects the lender, not you.
When you need it
As mentioned above, LMI is needed when you do not have enough money saved up to make a 20% deposit on a property. This allows many first-time homebuyers to purchase a property without having to save up tens, or even hundreds of thousands of dollars beforehand.
With housing prices continuing to rise, cheap houses for sale can be hard to come by, meaning that many Australians hoping to enter the housing market have to spend years saving up for their deposit. LMI gives lenders the confidence to provide you with a home loan without a 20% deposit, and certain lenders will loan you up to 95% of your home’s purchase price.
How much it costs
The cost of LMI depends on the loan amount and the percentage of the home’s value being borrowed. Other factors can also come into play, such as if the money you’re contributing came from your own earnings or if it was a gift.
LMI can often cost thousands of dollars, although it’s impossible to estimate an exact amount without knowing the circumstances behind it. It is a one-time payment that is non-refundable and is paid during the loan settlement process. LMI calculators are available for you to figure out just how much your premium will be.
How it affects your home loan
As taking out LMI means that the mortgage insurance company is responsible for the risk of your home loan, they may have a stricter approval process which may make it harder than usual to get a loan.
If you use LMI to buy your home, this means that you will most likely be taking out a much larger loan than if you saved up for a deposit. This means that your monthly repayments will be higher, especially if you choose to pay for your LMI by adding its price onto your home loan. When looking for real estate listings in your price range, make sure you’re accounting for this.
How to avoid it
One way to avoid paying LMI as a first time home buyer is to save up for your deposit yourself. If you already own a home and are interested in buying investment properties, you may be able to use your equity as opposed to saving up for another deposit.
Another way to avoid paying LMI is if your deposit is less than 20% but you have a guarantor for the property loan. As they add additional security to your home loan, they have the power to reduce the loan to value ratio and help you avoid paying LMI.
Lenders mortgage insurance can be complicated and comes with a certain amount of risk, so discuss your options with a broker before making any final decisions.