Lenders Mortgage Insurance (LMI) explained: what you need to know

When it comes to buying your first home, additional insurance fees are often last thing to spring to mind. But what if they offered a way to enter the property market sooner?

With Lenders Mortgage Insurance, you could buy your first home loan without needing to save up for a huge deposit. Though its benefits vary from one home buyer to the next, we've broken down some of the key things you need to know about this policy: what it is, how it works, and certain pitfalls to watch out for.

What is Lenders Mortgage Insurance?

Lenders Mortgage Insurance (also known as “LMI” or “mortgage lenders insurance”) is an insurance policy that covers the mortgage lender in case a “shortfall” takes place. A shortfall occurs when you, as the borrower, are unable to continue paying your home loan and this results in the property being sold for less than the outstanding loan amount (also known as a “shortfall debt”).

A few quick facts to know about LMI:

• LMI protects the lender, not you.
• LMI should not be confused with mortgage protection insurance, an insurance policy that protects mortgage borrowers in the case of death, disability, unemployment, or sickness.
• You needn't arrange an LMI yourself – typically the lenders do this for you.
• You may be able to avoid an LMI by saving a larger deposit or by having someone like a parent offering up some equity in their home through a guarantee.
• In the case of shortfalls, your lender may turn to an LMI provider to recover their losses. However, the LMI provider may also seek to recover this amount from you.

When do you pay Lenders Mortgage Insurance?

LMI is typically required when you borrow over 80% of your property's value.

This is calculated by comparing your home loan deposit to your property's “lender-assessed value” – also known as the market value applied to the property based on your lender's valuation of it. If your deposit is less than 20% of the lender-assessed value, this means you've got a Loan to Value Ratio (LVR) of over 80%.

Those with an LVR of over 80% usually require an LMI as this typically poses a high financial risk to the lender.

With LMI, lenders may be able to offer you a bigger home loan, sometimes as much as 95% of the property's value.

Here at Qudos Bank, for example, we offer home loans with current maximum LVR's of up to 95% before the LMI premium is applied subject to the loan and property type^[1].

How does Lenders Mortgage Insurance work?

LMI protects the mortgage lender in case you fail to meet your outstanding loan payments (also known as “defaulting” on your home loan). Though the property itself also acts as security for the loan, additional costs such as interest and fees may be added to one's loan repayments.

By the time it comes to sell the property (in the case of a mortgage default), the sale of the property itself may not be enough to cover all the outstanding loan debt. It's also possible for the property's market value to fall under the original sale price, leaving the lender at a loss when it comes time to re-sell.    

LMI can help effectively cover this risk. We'll use an example to illustrate:

• Let's say you decide to purchase a property valued at $700k AUD.
• You decide to take out a loan of $650k AUD, in which LMI is required and included.
• You default on your home loan, leaving the lender no choice but to sell the house. Unfortunately, due to changing market conditions, the house is sold at a loss of only 600k AUD.
• At the time of sale, your outstanding loan balance was at $670k AUD, which includes not only the original loan amount, but any accrued unpaid interest or fees associated with the sale.
• Calculating the difference between your outstanding loan balance and the lender's sale proceeds – this leaves a shortfall of $70k AUD.
• The lender may then turn to the LMI provider to claim the shortfall. The LMI provider may then turn to you to recover the shortfall amount.

The benefits of Lenders Mortgage Insurance

Though LMI may seem like a negative to new home buyers, they could also carve out an easier path to home ownership. If you're looking to purchase a property but haven't quite reached a substantial deposit amount (typically 20%), it can be difficult to find a lender willing to offer you a home loan.

With the financial risks passed on to the mortgage insurer, LMI grant lenders more confidence in offering you a home loan. This may allow you to enter the property market early or obtain a home loan that would otherwise not be available. Also, the policy may offer valuable support for those who come from particularly low-income or low-equity backgrounds, or due to certain factors (i.e. failing to make repayments in the past, having previously filed for bankruptcy, etc.) are considered a “high-risk” borrower.

It's important to note that a smaller deposit can increase the possibility of a shortfall debt, as there is less of a buffer between your outstanding loan balance and the property value.

What does Lenders Mortgage Insurance cost?

The cost of an LMI can depend on various factors, including:

• The size of your loan
• The value of your property
• Your LVR ratio
• Your employment
• The type of loan you get
• How your lender calculates the LMI

As an example, if you're a first home-buyer looking to get a home loan of $500k AUD for a property priced at $600k AUD has an LVR ratio of 83.33% - leading to an LMI estimate of $4,193.18 AUD (excluding stamp duty), according to Genworth Financials LMI Fee Estimator^[2]. You may also be charged with additional stamp duty (tax charged for certain documents and transactions) depending on the state or territory where your property is located.

Since costs can vary depending on your situation, it's best to talk to your lender for more information on how they calculate LMI and what the estimated price may be.

How does LMI get paid?

LMI is typically arranged by the lenders themselves – though the cost of the insurance premiums is then passed on to you. This can be paid as a one-off fee at loan settlement or can be included in the loan amount (it varies from lender to lender). LMI added to the home loan amount would mean you'll have to pay interest on the total loan, resulting in higher minimum monthly repayments. 

Is an LMI refundable or transferable to other lenders?

An LMI cannot be transferred to another lender. Should you refinance to a different home loan with an LVR of over 80%, you'll likely be required to pay for LMI again.

LMI is generally not refundable (but check with your lender and LMI provider).

Save for a bigger deposit or pay LMI?

Choosing between an LMI or saving up for a larger deposit will depend on your unique needs and financial situation. Those who can afford the minimum 20% home loan deposit may very well pursue the latter – while those who lack the savings, yet wish to buy property sooner, may benefit from an LMI.

LMIs can also be especially helpful in our current property market, as Australian house prices continue to rise. ABS statistics^[3] show that as of March 2022, median house prices in Sydney, Melbourne, and Brisbane have risen, leading to much higher 20% loan deposits as seen below.

   Median house prices and annual percentage change, March Qtr 2022   Capital city Annual change (%) Median house price ($) Estimated 20% loan deposit ($)   Sydney 16.4 1,245,000 249,000   Melbourne 9.4 930,000 186,000   Brisbane 29.3 787,500 157,500    

* Total Value of Dwellings 2022, Australian Bureau of Statistics^[3]

With 20% loan deposits ranging from $157,500 to $249k AUD, many first home buyers are likely to find the support they need through an LMI. It's also important to note that certain areas (typically those with high mortgage default rates) may require higher minimum deposits of 30% or even 40%.

However, if you're willing to wait a few years, and can save up for a larger deposit – then you may be less likely to need an LMI.

How to avoid paying for LMI

The most common way of avoiding an LMI is to save up for the minimum deposit required by your lender. Another way that could help you avoid paying for LMI is to get a guarantor for your home loan.

Guarantors (typically parents) can offer a property they own as additional security for your loan. However, if you're unable to meet your mortgage repayments, this property could be at risk of getting sold to recover the shortfall.

Looking to buy your first home?

Getting a home loan shouldn't stay a mere pipe dream.

Discover ways of successfully buying your first home by speaking with one of our experts at Qudos Bank. Sort out all your home lending needs, how much lenders mortgage insurance may cost for you, and whether it may be worth your situation.