Most Australians need to take out a home loan when purchasing a new property, whether they’re buying their own home or choosing one for investment purposes. Sometimes, however, lenders worry that the borrower won’t be able to repay the loan and, naturally, they want to protect themselves against this possibility. This is where Lender’s Mortgage Insurance (LMI) comes in.
But what exactly is LMI, who does it protect, and how does it affect you if you’re expanding your investment portfolio?
What is LMI?
LMI is a special type of insurance that protects lenders against high-risk home loans. For lenders, the smaller the deposit that a borrower puts down, the greater the chance that they won’t recover the total loan value.
Essentially, if a lender must loan over 80% of the property value, they’ll probably take out LMI.
Does LMI Protect Borrowers?
No, but it’s estimated that over 70% of Australian borrowers wrongly believe that LMI protects them. LMI only ever insures the lender, not the borrower. It allows lenders to recoup losses in the event a borrower defaults on mortgage repayments.
The good news is that LMI does make it easier for credit-worthy borrowers to obtain a home loan even if they only have a small deposit. This is because lenders transfer some of their own risks to a third-party insurer.
LMI, then, can help first-time property buyers or buyers without much capital purchase a home or investment property.
How Common is LMI?
LMI is fairly common—around 20% of mortgages in Australia are covered by LMI. It generally applies when borrowers make small deposits, such as 5% or 10% of the total value. The thing is, it can cost borrowers significant sums of money in the long run.
- You buy a $700,000 home
- You pay a 5% deposit or $35,000
- You must then borrow 95% of the home value = $665,000
- The LMI cost (based on current rates and loan calculations) = $29,990
In this example, LMI adds nearly $30,000 to the total loan cost. Online calculators exist to help borrowers estimate how much LMI is likely to cost them. We also have our own set of calculators to help you calculate repayments, property fees, and how much you can borrow.
How LMI Affects Borrowers
Borrowers pay back LMI over the loan’s lifetime. This means that they won’t pay LMI upfront. However, borrowers should ensure that they consider LMI costs when searching for a property and a home loan so there aren’t any unexpected repayments. Forgetting to factor in LMI can lead to a purchaser overstretching their finances, particularly if they’re building an investment portfolio.
Even if you can’t put down at least 20% deposit on a property, you might be able to avoid LMI if you:
- Work in a highly-regarded profession, such as law or medicine
- Have a perfect credit history
- Have a guarantor
Although LMI is made for lenders and can be costly for borrowers, it does offer a few advantages when it comes to the industry in general:
- It makes it easier for more borrowers to get home loans
- It offers the marketplace some degree of financial stability
- It promotes investment and property ownership.
How to Avoid or Reduce LMI
If you want to reduce LMI expenses or avoid it altogether, there are a few things you can do such as:
- Pay the premium as an upfront one-off fee to avoid monthly interest
- Shop around for the best value home loan
- Aim to have at least a 20% deposit for a property purchase
- If you can’t increase the deposit, choose a property which is likely to increase in value so that you’re not paying back more than it is worth
- Get help from experts who can assist you in choosing the right loan for your circumstances
We’re Here to Help
Getting a home loan can be challenging, and the hassle and confusion involved can lead to poor decisions. This is why we at Clever Finance Solutions are here to help—we’ll take the stress out of the loan process to make things easier for you. Through our experience, expertise, and professional network, we’ll help you secure the best loan for your needs and guide you in the other aspects of your property investment journey. Want to know more about how we can help? Please don’t hesitate to set a free no-obligation appointment with us today.