What is this Lenders Mortage Insurance or LMI all about then? This article gives you a full run down about Lenders Mortgage Insurance and some of the commonly asked questions.
What is Lenders Mortgage Insurance
When you consider that an apartment in Perth could set you back half a million dollars at the moment, saving a 20% deposit to buy that apartment – $100,000 – can seem an insurmountable task. That’s where Lenders Mortgage Insurance can help. Lenders Mortgage Insurance (LMI) is one way of getting into homeownership without having the 20% deposit (or 40% for low document loans), which is typically required by most banks and financial lending institutions.
LMI protects the bank or lender, should you let your home loan go into default, guaranteeing that the lender will get its money back if the property needs to be sold and there is a shortfall in repaying the loan.
How does LMI work?
Lenders Mortgage Insurance protects your lender against a loss should you as a borrower default on your home loan. If the security property is required to be sold as a result of the default, the net proceeds of the sale may not always cover the full balance outstanding on the loan.
Should this be the case, your lender is entitled to make an insurance claim to the LMI provider for the reimbursement of any shortfall.
What’s in it for you?
For you, it may seem LMI is just another expense to cover. But this insurance can enable you to enter the property market with, for example, only a five per cent deposit saved. In the example above, this brings the deposit down from $100,000 to just $25,000.
And, if the market is hot and prices are rising rapidly, paying LMI so that you can buy now could be cheaper than taking the time to save a bigger deposit. In the time it takes to save a higher deposit amount, property prices may well have surged by more than cost of the insurance so, for some properties and purchasers, it can make good financial sense to purchase earlier even with the added cost of LMI, especially when you consider the rent that you would pay while you’re saving.
When is LMI payable?
Lenders Mortgage Insurance typically becomes payable when:
- You have a Loan to Value Ratio (LVR) of over 80% for a full documentation home loan (standard home loans)
- You have a Loan to Value Ratio (LVR) of over 60% for a low documentation home loan (self-employed persons).
There are exceptions to the rule though. See below.
For example, if you earn a standard PAYG salary and you purchased a home valued at $500,000 with a $150,000 deposit, you would only be borrowing $350,000 which gives you a Laon to Value Ratio (LVR) of 70%. As this falls under 80%, you would not be required to pay the Lenders Mortgage Insurance.
However, if you only have $50,000 saved for a deposit you would be borrowing $450,000 from the lender giving you an LVR of 90%. In this case, the lender will require you to pay LMI as it will perceive you to be at a greater risk of defaulting on your loan repayments.
What are the exceptions?
There are some exceptions to the rules that may enable you to avoid paying LMI. Some of these include:
- Your LVR is only slightly over the 80% threshold
- Your lender has an internal LMI substitute
- Working in certain professions - you may be allowed to borrow up to 90% without paying LMI. These professions typically include:
- Medical Based Professionals
- Medical Specialists
- Law Professionals
- Energy, Mining and Resources Professionals
- Mine surveyors
- Quantity surveyors
- Other Professionals
In general the only surefire ways of avoiding LMI include:
- Saving a 20% deposit + costs. Don't forget that costs need to be covered as well. For example, on a $500,000 property purchase, costs (such as Stamp Duty, settlement costs, etc...) may run up to 5% of the purchase price in this case $25,000. So, for a $500,000 property, you may need $125,000 in funds to avoid LMI ($100,000 for the 20% deposit and the $25,000 for associated costs).
- Having an immediate relative act as a guarantor for you. See Guarantor Home Loans
Who is insured?
Your lender is the insured party, not you, the borrower, nor any guarantor.
LMI should not be mistaken for Mortgage Protection Insurance, which covers your mortgage in the event of death, sickness, unemployment or disability.
How is LMI calculated?
LMI is calculated based on two main risk variables to the lender and insurer:
- The loan amount. The larger the loan amount, the higher the risk for the lender/insurer.
- The Loan to Value ratio (LVR). The higher the LVR, the higher the risk is for the lender/insurer.
There are other variables that come into consideration too.
Below is an example Full Documentation LMI Calculation Table that can be used to give you a very rough LMI premium estimation:
|LVR Band||Up to $300k||>$300k - $500k||>$500k - $1m||>$1m|
|> 80% - 81%||0.5000||0.6400||0.8960||0.9920|
|> 81% - 82%||0.5000||0.6700||0.9380||1.0385|
|> 82% - 83%||0.5500||0.7100||0.9940||1.1005|
|> 83% - 84%||0.7300||0.9000||1.2600||1.3950|
|> 84% - 85%||0.7800||0.9800||1.3720||1.5190|
|> 85% - 86%||0.9200||1.2100||1.6940||1.8755|
|> 86% - 87%||0.9800||1.2700||1.7780||1.9685|
|> 87% - 88%||1.1200||1.3600||1.9040||2.1080|
|> 88% - 89%||1.1800||1.4200||1.9880||2.2010|
|> 89% - 90%||1.2700||1.6800||2.3520||2.6040|
|> 90% -91%||1.9700||2.5800||3.6120||3.9990|
|> 91% - 92%||1.9700||2.5800||3.6120||3.9990|
|> 92% - 93%||2.2100||2.9200||4.0880||4.5260|
|> 93% - 94%||2.2100||2.9200||4.0880||4.5260|
|> 94% - 95%||2.4300||3.2100||4.4940||4.9755|
For example, A $420,000 loan amount is required to purchase a property for $500,000. As the loan amount is between $300,000 and $500,000 and the Loan to Value Ratio (LVR) is 84% ($420k/$500k), the LMI premium would be $420,000 x 0.90% = $3,780 plus any state government charges.
Are LMI premiums the same from lender to lender?
No, and there can be large differences too. Different lenders use different LMI providers, have different loading policies and some even have a delegated underwriting authority. All of which can yield different LMI premium amounts for the same set if circumstances.
What is the maximum LVR for LMI?
Typically, most lenders will lend up to 95% Loan to Value Ratio inclusive of the LMI premium. There are a few lenders that will even go up to 97% inclusive of LMI.
When do you pay the LMI premium?
Unlike traditional insurance premiums, LMI is usually a once only premium (cost) payable at loan settlement that provides cover for the full term of the loan. Usually, your lender will pass on the cost of the LMI premium to you as a fee.
Some lenders will allow the premium to be capitalised into your loan or it may be paid upfront.
What is LMI capitalisation?
LMI capitalisation is the process whereby your lender adds the cost of the lenders mortgage insurance into the loan amount.
For example, if you borrowed $500,000 and the mortgage insurance premium was $10,000 the lender would normally take the fee from the amount borrowed leaving you with only $490,000.
With LMI capitalisation, the lender will allow you to borrow an additional $10,000 making your final loan amount $510,000. This gives you the full $500,000, which you originally applied for.
Capitalising your LMI premium means you'll need a smaller deposit as you are now not paying for the LMI premium from the money that you have saved.
Do you have to pay GST on LMI?
GST is payable on all LMI premiums and is included in the total cost quoted by your lender. Subject to various State Government regulations, stamp duty may also be payable on LMI insurance premiums. Where applicable, this amount is also included in the total cost.
How can you avoid LMI?
There are two main ways to avoid paying Lenders Mortgage Insurance:
- Save 20% or more as a deposit. Don't forget about the property purchase costs too.
- Find an immediate relative to act as a guarantor for your loan.
Who provides LMI to the lenders?
In Australia, at the time of writing, there are two main mortgage insurance providers: Genworth Financial and QBE LMI.
Some lenders are covered by QBE, others by Genworth, some even use both and some simply cover themselves. There are some lenders that have Delegated Underwriting Authority too, which enables them to approve your loan in-house, on behalf of the insurance provider.
A simple LMI Example for Perth
You work for the City of Perth, are a paid salary (full documentation loan) and are looking at purchasing a property worth $500,000 and have $60,000 in savings. After deducting the WA Stamp duty (assuming you are not a first home buyer) and other associated purchase costs (assumed 5% in total to be prudent), you are left with $35,000 to pay the deposit.
You will need to borrow the remaining shortfall from a lender, in this case, the total require funds will be $465,000.
Your Loan to Value Ratio will be 93% ($465,000 / $500,000). Given you're over 80% LVR, your lender Mortgage Insurance premium will be payable.
After the LMI premium of $16,000 is capitalised, your final loan becomes $481,000 and your final LVR is 96.2% ($481,000 / $500,000). As well as paying a large LMI premium, your choice of lenders is now limited too, as not many lenders, allow you to borrow up to 97% inc LMI... a couple do...
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