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Lenders mortgage insurance is a tricky concept that not many fully comprehend. It is important to understand that LMI insures the lender, not you. Here is everything else you need to know about LMI
Most mortgage lenders require that the borrower put their own cash into the property, starting at an ideal 20 per cent of the purchase price. This 20 per cent equity in the property makes the loan a low risk for the lender: with such a lump sum tied-up in the property, the lender believes the new owner will work hard to make the repayments so they don’t lose their equity.
But what if you have good income and a good credit history, but your deposit doesn’t come to 20 per cent? Perhaps you have 18 per cent? Or 13 per cent? A loan with a deposit under 20 per cent represents a higher risk for the lender, yet they still might see you as a good bet. In this case the lender could buy insurance to cover their higher risk. It’s a product called Lenders Mortgage Insurance (LMI).
What should you know about LMI?
- LMI insures the lender, not you. It covers the shortfall should you default on your mortgage and the property ends up being sold for less than the outstanding loan balance plus some costs.
- LMI is not Mortgage Protection Insurance, which covers your repayments should you die, lose your job or become incapacitated.
- You pay the premium for the insurance up front, either from your deposit, or sometimes it can be added or “capitalised” into the loan, meaning you pay it off as you make mortgage repayments.
- LMI helps many borrowers into the property market when they have less than 20 per cent deposit. If the lender is happy with your income and your prospects for repayment, LMI allows you to get a mortgage with a deposit as low as five per cent of the purchase price.
- The cost of LMI varies according to deposit size, loan size and type. But here’s a general example: if you want to buy a $500,000 property with a $50,000 deposit, you only have 10 per cent. At current rates and a standard loan, your LMI costs could be around $8,000.
- LMI can slow the home loan process because the lender has to have the insurance approved by its insurer. When sourcing a loan with LMI it’s a good idea to have a ore-approval from the lender before making an offer on a property.
- Don’t forget that when you use LMI to get into the property market sooner, you have to borrow more to buy the property than if you had a 20 per cent deposit. When you add the LMI premium in to the higher loan amount, it’s a more expensive loan, this needs to be balanced off with your view as to where property prices are headed. If you feel prices are on the rise, getting into the market sooner with LMI may prove to be a money saving alternative to waiting until you have accumulated your 20 per cent deposit.
Lenders Mortgage Insurance allows a smaller deposit and a larger loan ratio, thus allowing borrowers to buy the property they want. The downside of a small deposit and LMI is that you incur higher costs than if you’d saved the 20 per cent deposit. Either way, it’s a good option to help you get on the property ladder or increase your portfolio.
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