You've probably begun to realise saving for a home loan isn't just about the deposit. There are a few other costs involved including Government fees, conveyancing costs, home and contents insurance and in some cases Lenders Mortgage Insurance (LMI). So what is LMI and who actually needs it?
What is LMI?
LMI is an insurance required by the lender for home buyers who aren't able to provide the minimum deposit required to avoid mortgage insurance. This is usually a 20% deposit which gives you a Loan to Value Ratio (LVR) of 80%. If a home buyer has a small deposit and the LVR is over 80% the loan is considered to be a higher risk to the financial institution.
LMI isn't insurance for you (the home buyer) or your guarantor; it's an insurance policy that covers the lender against loss in the event that you can no longer meet your loan repayments. The premium is a once off payment paid by you, at settlement and is usually added to the home loan.
If your deposit is less than 20% you are most likely going to have to pay LMI. For example, if you want to buy a house for $500,000 but have only saved $50,000, you have an LVR of more than 80% as you need to borrow more than 80% of the value of the house.
How does it work?
In the unfortunate event that you are no longer able to pay your home loan repayments, your house may be sold. If the proceeds of the sale do not cover the full amount you owe to the lender, the difference is covered by the LMI provider. The LMI provider may then seek to recover the gap from the borrower.
How does it benefit me?
The main benefit of LMI is for the lender, as they are being protected should you not be able to pay off your loan. However, LMI also means your savings journey will be shorter as you may be able to provide a smaller deposit for your dream home which means you'll be in the property market quicker. This could mean you can stop paying rent earlier or you could buy yourself a better property than you thought possible.
What is the cost of LMI?
The cost of LMI depends on how much you want to borrow and how much deposit you have. The bigger the deposit, the lower the cost of LMI. Additional discounts or loadings may apply, so have a chat to your Home Loan Adviser (HLA) about what is possible for you. Usually the LMI fee is added to your loan but you can choose to pay from your own money if you wish. Keep in mind that if you add the cost to your loan, you will pay interest on this over the life of your loan. Again, your HLA will be able to provide details of what options are available to you.
Keep in mind that is LMI is generally non-refundable and it can't be transferred. This means if you decide to refinance your home loan with another provider, you may need to pay LMI again depending on your financial situation.
How do I avoid paying LMI?
To avoid LMI, aim to save enough money to cover at least 20% of the property price as well as other Government fees such as stamp duty. Another way to avoid paying LMI is to find a guarantor. A guarantor takes the risk if you are no longer able to afford your home loan. This is a common option for first home buyers as it can be hard to save 20% for your first home.
What's the difference between LMI and Mortgage Repayment Protection?
It's important to note that LMI and Mortgage Repayment Protection (MRP) are two different things. MRP protects you if an unexpected event occurs and you can't pay your mortgage for a certain period of time. For example, an illness or injury has stopped you being able to go to work for a few months. During this time, MRP may make some of your repayments for you or pay a lump sum to help you through this time. This is an optional insurance but something worth considering. Have a think about if you or your partner were no longer working, would you still be able to afford your repayments?
If you are suffering financial hardship or experiencing problems and you cannot make your loan repayments on time you should immediately contact your Home Loan Adviser to discuss your situation.