As property prices continue to reach record levels, saving up a deposit for your home is as hard as it’s ever been.
With the median house price in Melbourne nearing $1,000,000, building a 20% deposit (plus the cost of stamp duty) requires years of scrupulous saving and can hold first home buyers back from entering the market.
Paying for Lenders Mortgage Insurance is a common way around this problem, allowing borrowers to take out a loan with a smaller deposit.
In this blog, I’ll break down what Lenders Mortgage Insurance is and whether it’s a necessary cost when financing your home.
What is Lenders Mortgage Insurance?
LMI is an insurance policy that protects the lender from financial loss if the borrower is unable to make the repayments on their home loan.
In the case that a borrower defaults, the lender will often try to recover their money by putting the property back on the market. If the property sells for less than the unpaid value of the mortgage, the lender risks making a loss on that loan.
This is why most lenders require at least a 20% deposit to approve a home loan. Banks are conservative in nature and prefer to pass the risk off via insurance, despite the unlikelihood that property prices will fall by more than this amount.
For a home buyer to take out a loan with a deposit less than 20%, the lender will want a guarantee if you are unable to meet your mortgage repayments.
Enter Lenders Mortgage Insurance (LMI).
Lenders can claim on an LMI policy to cover the difference of what they are owed on a loan. Because the mortgage insurance company insures the lender against the borrowers risk, they will be more likely approve a loan without requiring a substantial deposit.
It is important to note; LMI is only to protect the lender. It won’t cover the borrower (or a guarantor) if they default on their loan, even though they usually carry the cost of the policy.
The cost of LMI is typically paid up front, with some lenders allowing it to be added onto the home loan (also known as ‘capitalising’).
How does Lenders Mortgage Insurance help?
Although you are paying for an insurance policy that won’t actually cover you if things go wrong, LMI will allow you to borrow more.
When a Loan to Value ratio below 80% cannot be reached, an LMI policy might be easiest way to finance the home that you are after. With Lenders Mortgage Insurance, a borrower may only need a deposit as low as 5% to take out a home loan.
For many first home buyers who are unable to save up the 20% deposit, LMI is a necessary expense to help them break into the market sooner.
As Australian property prices continue to grow, there will be an increasing dependance on Lenders Mortgage Insurance, particularly for buyers in inner-suburban and higher demand areas.
Should I get Lenders Mortgage Insurance?
Whether or not you should get Lenders Mortgage Insurance will depend on you individual circumstances.
In Victoria, first home buyers might be able to avoid paying LMI through the First Home Loan Deposit Scheme. Through this scheme, the government will act as a guarantor for eligible individuals, allowing them to borrow with a deposit between 5% and 20% of the property’s value.
For others, LMI might be the fastest way to enter the property market, letting you take advantage of growing house prices without years of saving up a deposit.
A bigger loan can be the difference between buying where you want to live versus buying where you can afford.
As property prices historically outperform interest rates, the value of your property could well grow faster than the interest you pay.
On the other hand, LMI will increase your debt and therefore the interest you’ll need to pay. For a loan paid over 20-30 years, it can be worth tens of thousands of dollars.
You should also be factoring in your ability to pay off the debt. Taking out a loan that stretches yourself too thin can put you at great risk during times of financial hardship.
If you’re not wanting to pay for LMI and haven’t yet acquired a deposit worth 20%, it might be best to hold off buying property for the time being.
With all the excitement that comes with a property purchase, your first priority should be ensuring the financial safety of you and your family. Know your capacity to repay the loan and plan for scenarios in which your personal or employment situation changes.
To learn more about LMI, get in touch with your mortgage broker or seek advice from a trusted professional.