Mortgage insurance, also commonly known as lender’s mortgage insurance or LMI, is used to protect lenders in case a borrower defaults on their loan. It is important to understand that LMI does not give the borrower any protection and in fact the insurer could come after the borrower for any shortfall in recovered funds.
The Australian Prudential Regulation Authority (APRA) has standards for mortgage insurance for both banks and mortgage insurance providers. This is to ensure that these financial institutions are capable of withstanding some risk and are sufficiently protected in the case of a high number of defaults. In fact, it was the presence of sound mortgage insurance practices that helped protect Australia during the global financial crisis.
While it may seem that LMI is just one more hurdle to doing business as mortgage insurance providers tend to be stringent when it comes to approving a policy, when you step back and look at the overall picture, LMI plays a vital role in stabilising Australia’s property markets. Ultimately, it provides benefits to both property purchasers and lenders.
It pays to be well-informed, as such here are the five most important things you should know about mortgage insurance.
1. 20% Is the Golden Number – In general, for a home loan that finances more than 80% of the purchase price, mortgage insurance is required and is organised by the lender. This for full doc loans, for low doc loans, which are considered to come with more risk, LMI is typically required for more than 60% of the property purchase price. The idea is that the more savings a borrower has, the less risky they are to a lender. This isn’t based on opinion, but rather on historical data.
This means that in general if you have a deposit of 20% or more for a property then you won’t have to pay mortgage insurance and you’ll save yourself a lot of money.
2. There Is a Way Around LMI, but the APRA Cautions Against It – Still, with the high property prices in Australia today, waiting to save up $120,000 on a $600,000 property, for example, isn’t always realistic.
There is one way to avoid LMI that doesn’t involve a sizable savings account: guarantor loans. By securing a guarantor, you can borrow up to 105% of the purchase price of the property. Guarantor loans are on the rise in the wake of rising housing costs; many Australians are getting help from their parents to enter the market by using their properties as a guarantor.
3. Mortgage Insurance Costs Vary Based on These Two Factors – There is no set cost of mortgage insurance. In Australia, unlike other countries, mortgage insurance providers are privately owned, and generally a bank has a relationship with only one insurer. To determine how much mortgage insurance will actually cost a borrower, a sliding scale is used, based on the amount of the loan and the loan-to-value ratio or LVR.
This means that for borrowers who don’t have a 20% deposit, it is possible to reduce the amount of mortgage insurance you’ll pay by negotiating a lower purchase price, or by putting in more of a deposit.
4. Mortgage Insurance Is More Common than You Think – Mortgage insurance is widely used in Australia. It is estimated that more than one-quarter of all Australian housing loans are covered by mortgage insurance. This demonstrates how useful LMI has been in keeping the property market going. Without insurance, many of these properties wouldn’t have been purchased.
5. LMI Standards Are Subject to Change – Banks and borrowers aren’t the only ones who have to prove their financial strength in order to play in the Australian property market. The lenders mortgage insurance companies are subject to intensive supervision as well. In fact, they undergo ongoing monitoring to assess their risk level and financial stability.
It can be a challenge to keep up with all the rules and strategies of property investing, especially when you’re new to the scene. The experts at Clever Finance Solutions are always available to offer advice when you need it.