Written by The Australian housing market moves fast, and prices seem to get higher and higher each year. That’s why it makes sense to become a homeowner sooner rather than later. After all, once you own a house, rising prices become a benefit, not a barrier. Yet, a healthy property market can make saving a down payment an even bigger challenge for many of us, and when you’re looking to get on the property ladder, a 20% deposit is often easier said than done. Getting started with property is the hardest part. A deposit is a big hurdle to get past, and with interest rates so low, many buyers don’t want to wait several years to own their home. In a lot of ways, it’s a great time to get a mortgage, and that’s where lenders mortgage insurance (LMI) can help. LMI is a one-off insurance premium for home loans. If you’re buying a home or investment property and you need to borrow more than 80% of the purchase price, you’ll need to pay LMI.
What is LMI?
All home loan lenders make decisions based on risk. That goes for whether you’re buying a house, a car, or just applying for a personal loan. When you approach a home lender with a 20% deposit, it signals you’re likely to repay your mortgage with no issues. Having such a sizeable lump of cash tied up in your house or apartment displays commitment, and that’s what lenders want to see. Buying a home with less than 20% of the asking price upfront is more problematic, and LMI is designed to compensate for that.
Let’s say you want to own a home now, but you haven’t saved up a 20% down payment. LMI is a way to protect the lender against the potential losses resulting from a default. To them, it’s as good as you turning up with the deposit because the insurance pays out if you experience financial difficulties during the term.
Buying a house with less than 20% deposit means you’ll likely increase the figure you need to borrow. That’s because your lender will allow you to add the cost of LMI to your loan. You’ll need to budget for that when you look for a home, so it’s helpful if you know how much you’ll need to pay. In a nutshell, LMI isn’t complicated:
- It’s a one-off insurance premium that you pay when you take out a home loan with a deposit equal to less than 20% of the purchase price.
- You won’t need to look for LMI. Lenders will arrange the insurance for you when you apply for a home loan with less than 20% deposit.
How is LMI calculated?
LMI gets calculated according to a few different factors. The first is the loan to value ratio of your home loan, also known as LVR. That basically expresses your loan amount as a percentage of the value of your home. The second factor is how much you need to borrow. The higher your home loan, the more LMI you’ll need to fork out too. For instance, if your new home is worth $500,000 and you save a $100,000 deposit, your LVR will be 80%. In that case, you won’t have to pay LMI because 80% is the magic number for homebuyers. However, if your LVR rises above 80%, that’s when the requirement for LMI kicks in. Here’s a rough guide to how LMI gets calculated based on your loan:
| Property Value & LVR | Up to $300,000 | $300,001 - $500,000 | $500,001 – 750,000 |
|---|---|---|---|
|
80 – 81% |
0.5% |
0.6% |
0.71% |
|
81 – 82% |
0.60% |
0.73% |
0.85% |
|
82 – 83% |
0.66% |
0.85% |
1.12% |
|
83 – 84% |
0.70% |
0.96% |
1.25% |
|
84 – 85% |
0.75% |
1.07% |
1.4% |
In the table, the rate for LMI gets based on the total value of your new home and the LVR. Let’s take that $500,000 house again. If you use a $75,000 deposit instead, your LVR increases to 85% – so you’ll pay 1.07% of $500,000 in LMI. That means you’ll be adding $5,350 to your home loan.
Our table only runs up to 85% LVR, but you can borrow up to 95% of your home’s value. You can expect to pay around 4% LMI when you get to that point, however. On the same $500,000 home, that would equate to approximately $20,000.
Your LVR isn’t the sole influencer on LMI. Additionally, if you’re looking for an investment property home loan, you’ll pay more LMI than if you intend to live in the house. That’s because lenders see homes as being less risky than buy-to-let properties. It’s less likely a buyer will default on the place where they live than on an investment.
Another factor in calculating LMI is employment. Self-employed homebuyers will pay slightly more than full-time employees. Again, the thinking behind that is risk-based. It’s about your job and income security. The more reliable your income, the less likely you are to default.
The pros and cons of Lenders Mortgage Insurance
House prices don’t always rise, but in Australia, they mostly do. LMI means your home loan will be a little larger, but the trade-off is you can get on the property ladder sooner – and that means you’ll likely benefit from a better purchase price.
Rising property values don’t just mean higher house prices. Your deposit is a percentage of your home loan, so as that increases, so does the deposit. If you can’t afford to save at a fast enough rate, house prices can work against you and keep you saving for years.
LMI is designed to make borrowing viable for homebuyers with lower deposits. These days, home loan lenders just can’t risk approving a 95% mortgage without some added protection in place. LMI provides the buffer a home loan provider needs to approve your mortgage.
When you buy your own house, appreciating value is better than money in the bank. Paying rent while you try and save for a deposit is dead money. LMI is a quicker route to ownership, and that means fewer wasted dollars. It also means you start benefiting from the property market immediately.
LMI can be a significant cost to your home loan that will increase your monthly payments. If you decide to buy a house with a small deposit, you’ll likely need to tweak your budget to allow for that.
Qualifying for LMI means you’re not applying for one single product. As well as applying for a home loan, you’ll need to apply for LMI too. That means passing the lender’s tests, but also the insurance provider’s.
More lenders mortgage insurance questions
Most homebuyers capitalise their LMI premium. That’s just a fancy way of saying that they add it to their home loan and pay for it over time. That means two primary things – their home loan gets bigger, and they’ll pay slightly more interest during the term.
It’s nearly always better on paper to borrow less. All borrowing costs money, but the fact is that waiting to buy in an upwardly mobile property market can be expensive too. Consequently, the answer to this question will vary depending on your circumstances and goals. If you earn enough to save quickly, maybe it’s better to wait. If you don’t, it could be better to pay LMI. As always, get good advice and think before you commit.
Your LVR can change for the better if you stay in your home and make enough repayments to bring your equity up. It’ll also change as the value of your home increases over time – or as you make improvements.
You can still get a mortgage when you work for yourself. However, you may pay a different interest rate, and having a lower deposit will also mean you pay slightly more for LMI.
There are four possible ways to avoid paying LMI. Firstly, you can save enough to get your LVR below 81%. Secondly, you could use a guarantor to raise a deposit. Thirdly, if you have a willing relative, you could look at a family pledge home loan. And lastly, if you’re a first-time buyer, you could apply for a First Home Owner Grant. That’s a government assistance scheme to help new homeowners buy without a significant deposit. Places are limited, and you’ll need to meet specific requirements to qualify in your state.
LMI isn’t transferable, which means you can’t take it from home loan to home loan with you. If you move or refinance your house, for instance, you’ll need to take out a new LMI policy too. That’s unless you achieve an LVR of 80% or lower before you make a move. Plan wisely, and you’ll only need to get LMI once.
Lenders mortgage insurance – as the name suggests – protects the lender, not the homebuyer. It’s important not to confuse LMI with mortgage protection insurance, which protects you if you lose your job, become ill, or get injured and can’t work.
Whether you pay your LMI premium as part of your mortgage or not, you’ll have to pay a different rate of stamp duty depending on the state you’re buying a property in.
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