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By Natalie Dictado from YBR Edmondson Park
Recently I helped some clients of mine navigate the sometimes-tricky aspect of LMI – don’t worry we will get into this shortly.
The beautiful couple came to me as they were looking to upgrade their existing home, to go from a villa to a spacious family home. The issue? They only had an 8% deposit saved.
The sale proceeds that could be generated from their existing villa didn’t quite cover the 20% deposit most lenders are looking for, or the costs of stamp duty.
The resolution? We were able to incorporate the LMI fee into their home loan, so they were able to retain some cash savings to complete the purchase of their family home and complete some bathroom renovations!
I realise this might not be applicable to every borrower, but it’s a reminder that there are strategies to navigate LMI to make your dream purchase possible, with the right guidance.
So what is LMI?
Lenders mortgage insurance (LMI) is something you won’t really think of until you try to buy a home. Then you realise everyone’s talking about it and all of a sudden you’ll have read 40 articles and spent hours googling only to feel like you understand it even less.
Lenders mortgage insurance is basically a fee charged to you by the lender when there is some ‘risk’ involved in giving you a loan. Technically, it is insurance taken out by the lender – it covers them against the risk that they might not be able to recover the loan if you default.
This means that, while the cost of the insurance is rolled into your loan, it covers the lender, not the borrower. (If you want insurance against that risk you would look into mortgage protection insurance).
When do you need to pay LMI on a loan?
The most common case where LMI is required is when your deposit is less than 20%. If you are able to meet your lenders requirements, but can’t quite make the 20% deposit, then paying LMI is a way of getting that loan application over the line.
When someone comes to us looking to buy a property, we take a look at how much of their savings they will have to contribute, or potential “equity” we can access from their existing property, to help them secure their next one. Then we can start looking at appropriate lenders and talk to them about strategies to reduce or avoid it where we can.
It’s a key component of our role as a mortgage broker: to negotiate with lenders to get you the best possible loan, at the best interest rate, and with the lowest fees.
How do you pay for it?
LMI can be paid upfront or rolled into the total cost of your loan. If you add it into your loan, it will of course increase the interest you pay on the loan and therefore your minimum monthly repayments. It’s a non refundable fee and not transferable should you refinance.
How much do you pay for LMI?
How much you pay for LMI is going to vary considerably from loan to loan. It depends on the amount you borrow, the value of the property you’re purchasing, the type of loan, as well as other elements of your financial situation and the insurance provider used. In any case, the greater your loan-to-value ratio, the higher the premium you will pay.
Some lenders apply premiums for certain customers, such as those that are self employed, so it pays to shop around.
There may also be another stamp duty added to your premium (Yes, it’s another stamp duty, not the one you’re charged when you purchase a property.) In NSW this is 9% of the premium.
Can you avoid paying LMI?
There are a few strategies you can use to avoid paying the LMI premium or at least reduce it.
- Pay the full 20% deposit plus upfront costs.
This one is obvious but sometimes it’s worth just saving a little longer, going for a smaller home as an initial investment or budgeting a little differently. It’s definitely going to depend on you and your financial needs and priorities. Keep in mind that the lower your loan-to-value ratio is, the lower the cost of the LMI.
- Invest with a friend or family member.
The goal here is to get to that 20% deposit that avoids the LMI. This could mean using a family (or friend) to act as guarantor or simply co-investing if that works for you both. A family guarantee means that the guarantor uses the equity in their home to guarantee the rest of your deposit so they will have responsibility for your loan if you default.
- Enter into a shared equity agreement (SEA).
In SEAs a property owner funds part of the property purchase on the agreement that the first home buyer buys the equity partner out later.
This helps you get to that deposit requirement and might mean considerably less to no interest on that portion of the loan.
- Accept a financial gift.
A financial gift is a payment from a friend or family member that is used as the deposit. This can be enough to get you over the line if you’re struggling to get the last few thousand together for that 20% deposit.
- Access a home grant.
There are a variety of loan deposit schemes out there for first home buyers or single parents. These allow eligible applicants to access a home loan, reducing the deposit amount required in some way and so avoiding LMI. They have a variety of conditions but may work for you.
- Take advantage of waivers / professional home loans.
Some lenders and some of the grants offer waivers or altered requirements depending on your profession, this might include military or medical professionals.
- Check out multiple lenders.
It might seem obvious, but remember that each lender is able to offer a different range of loan options. Shop around. Use a mortgage broker. Seek professional assistance of some sort. There are many loan options out there and there might be one which takes LMI out of the equation or at least reduces it for you. As this saves thousands in the long run, it’s definitely an important step.
Pros and Cons to paying LMI
Reality is LMI is just part of the home loan world. But there are times when it’s worth it and times when it’s not.
If, for whatever reason, you need to get into the housing market sooner, your deposit may be lower but, with LMI, you can secure your home and get onto the property ladder. Or it may enable you to purchase a property that’s better than you may otherwise have been able to afford.
On the other hand, if you continue to save for a larger deposit, or find another way to access the loan with a smaller deposit, then the LMI will be less, if not removed, and your mortgage repayments reduced.
While LMI is usually calculated at somewhere below 5% of the loan it can add up quickly, so purchasing with a smaller deposit can end up costing many thousands in the long run.
To pay or not to pay?
Ultimately the decision to enter into a mortgage that requires the inclusion of LMI is an individual one, based on the needs and wants particular to you and your situation.
It can be the tool that gets you into that long sought after property, or the cost that makes you rethink a potential investment. Either way, you deserve to carefully consider LMI when calculating the cost of your home loan journey.