If you’re a first home buyer in Australia, you might have come across the term Lenders Mortgage Insurance (LMI). Understanding what LMI is and how it impacts your home-buying journey is crucial as you navigate the process of securing a mortgage.

What is Lenders Mortgage Insurance (LMI)?

Lenders Mortgage Insurance is a type of insurance that protects the lender, not the borrower, in case you default on your home loan repayments. It is generally required when a borrower has a deposit of less than 20% of the property’s purchase price. In other words, if you want to buy a home and your deposit is less than 20%, the lender will likely ask you to pay for LMI.

Why Do Lenders Require LMI?

Lenders consider loans with a higher loan-to-value ratio (LVR) to be riskier. The LVR is the amount of your loan compared to the value of the property. For example, if you have a deposit of 10%, your LVR is 90%. LMI helps lenders mitigate the risk associated with lending a large portion of the property’s value. By having LMI in place, lenders are protected from potential financial losses if the borrower fails to make loan repayments.

How is LMI Calculated?

The cost of LMI depends on several factors, including the size of your deposit, the amount you are borrowing, and the lender’s policies. Typically, the smaller your deposit, the higher the LMI premium you will need to pay.

For example:

– If you are buying a home valued at $500,000 and have a 10% deposit ($50,000), you would need to borrow $450,000. The LMI premium might be around 1-2% of the loan amount, which would translate to an additional cost of $4,500 to $9,000.

– If your deposit is 5% ($25,000), you would need to borrow $475,000. The LMI premium could be higher, potentially around 2-3% of the loan amount, meaning an additional cost of $9,500 to $14,250.

How is LMI Paid?

LMI can be paid upfront as a lump sum when you settle your loan, or it can be capitalised into your loan amount, which means it is added to your total loan balance and repaid over the life of the loan. While adding LMI to your loan can reduce the immediate financial burden, it will increase your monthly repayments and the total interest paid over the life of the loan.

Benefits and Drawbacks of LMI

Benefits:

Access to the Property Market Sooner: LMI allows you to purchase a home with a smaller deposit, which can be particularly beneficial in a rising property market where saving a larger deposit could mean the property price increases outpace your savings.

Flexibility: LMI provides an opportunity for borrowers who do not have a 20% deposit to secure a home loan, thereby making homeownership more accessible.

Drawbacks:

Additional Cost: LMI can add thousands of dollars to your home-buying costs, either upfront or through increased loan repayments.

No Protection for Borrowers: Unlike other types of insurance, LMI does not protect you, the borrower, in case of financial difficulty. It solely protects the lender

Avoiding LMI

One way to avoid paying LMI is by saving a deposit of at least 20%. Alternatively, you can explore government schemes such as the First Home Guarantee (FHBG), which allows eligible first home buyers to purchase a property with as little as a 5% deposit without needing to pay LMI.

More Information

Book a FREE consultation with Brendon Cowan at Finance Broker Melbourne today.