While no one likes the sound of paying extra fees when buying a home (especially for insurance that protects the bank!), LMI is often the key to helping first home buyers (or upgraders) get into the property market. Paying it doesn’t necessarily have to be viewed as a bad thing, and it’s a handy tool for people wanting to get into their first home sooner.
What is Lenders Mortgage Insurance (LMI)?
If you’re looking to buy property but your deposit is less than 20% of the property purchase price, you will likely find yourself being charged Lenders Mortgage Insurance (LMI). LMI is insurance taken out by the bank in order to lend to borrowers with a smaller deposit. The risk of lending is then transferred from the bank to the insurer.
Lenders on-charge the LMI premium cost to you - the buyer - for the purpose of protecting the bank (not you!) in the event that you default on your mortgage. It is a one-off payment that can be paid in a lump sum at settlement or added to the principle of your loan. It actually makes more sense to add the LMI to the loan as it means you are paying a bigger deposit and reduces the Loan to Value Ratio (LVR) which means a smaller LMI premium.
It’s important to not confuse LMI with Mortgage Protection Insurance (MPI). MPI covers you if you’re unable to meet your mortgage repayments due to unemployment, death or disability. LMI protects the lender if you default on your loan payments and the property ends up selling for less than the outstanding loan balance. Once the bank gets paid out, the insurer may come after you as the borrower to recover costs.
How much does Lenders Mortgage Insurance cost?
This really depends on the purchase price of the property, how much you are borrowing, the size of your deposit and the lender you choose. Like stamp duty (first home buyers are exempt from paying stamp duty up to $600,000 and receive a discount up to $750,000 in some states), LMI is calculated on a sliding scale: as your loan amount and Loan to Value Ratio (LVR) increase, the more you will have to pay for LMI. Think of it like car insurance when you first get your drivers license, the less experience you have (the less deposit you have) and the higher the value or type of car you have (the higher your loan amount compared to the value of the property), the higher the premium. Be warned, it is likely to equate to several thousands of dollars, but is that really a bad thing? Let’s deep dive a bit further.
For example, let’s say you were a first home buyer looking to purchase a $700,000 property in Melbourne. If you were to borrow around 85% of the property price ($600,000), your LMI premium would be around $8,555 according to the Genworth LMI Premium Calculator. However, if you were to borrow up to 92% ($650,0000), the LMI premium skyrockets to around $24,469.
LMI premiums can also vary from bank to bank, depending on their criteria and the insurance provider they use. The loan type, whether the property is owner-occupied or investment, whether you have genuine savings (5% of the purchase price in savings in your bank account for 3-6 months) or are self-employed are all factors that may be considered when determining LMI premiums.
Before you choose a lender, it’s worth researching and considering the different LMI premiums they offer. Just don’t get caught up in trying to save money on LMI at the expense of your interest rate as LMI is a once-off cost while the interest rate is ongoing. Some lenders will have lower LMI premiums but higher interest rates for first home buyers. While you may save money on the once-off LMI premium, you will end up paying more in interest over the length of your loan. LMI is also lender specific and not portable which means that if you decide to refinance later down the track and you are still borrowing above 80% of the property’s value, you will most likely have to pay LMI again.
Should I wait and save a larger deposit?
There it is folks, the million-dollar question - should I pay LMI and jump into the market now, or wait and save a higher deposit? Unfortunately, there’s no right or wrong answer and it depends on your individual circumstances and goals.
Saving 20% for a house deposit is no easy feat in this day and age. Currently, the median national property price in Australia is $549,918. That means a first home buyer needs over $100,000 in savings for a 20% deposit for purchasing their home. If you do decide to stick it out and save over a number of years, you may find that once you’ve saved that 20% the price of property has increased and you need to continue saving, something that you are probably very aware of given the state of the property market at the moment.
When it comes to the right time to buy, buyers agents Michael Lykowsk & Kosta Moussageas from Alfy Property explain.
“Too many times in my real estate career have I heard people say ‘I’m just going to wait till the market has a downturn’.
There have been the lucky few that have purchased right at the bottom of the market, but these instances are few and far between. Even the most savvy of economists are taking educated guesses for when this may be. Our advice has always been to purchase as soon as you are financially capable, regardless of the current market conditions.
We have provided a snapshot of the median price changes of 5 very different suburbs over an 18 year period for you to download and consider. These graphs show how rare and negligible the downturns can be and also how quickly some of the growth can occur.”
Another common scenario for some first home buyers is if they should purchase a cheaper home in order to have a 20% deposit to avoid LMI and upgrade in the future. This may seem like a logical choice to avoid the cost of LMI, however it could be a false sense of economy. Why is that you might be thinking, let’s run some numbers:
If you weigh up the cost of selling a property, you’re looking at around $13,000 in agents fees. Then, you’d need to pay stamp duty on the new property, as you only get the stamp duty exemption as a first home buyer once, which would be around $37,000 for a $700,000 home. That’s around $50,000 in extra costs to sell the property and upgrade. Not to mention you would also need a $177,000 deposit to avoid LMI on your new purchase. So depending on the circumstances, you may still end up paying LMI on your next purchase as well! If you were to purchase the $700,000 property with a deposit of $100,000 and pay LMI at the very beginning, you would only be out of pocket $8,500 and in your dream home a lot sooner.
While it may have a bad reputation, LMI can help borrowers with a deposit as low as 5% get the keys to their new house sooner rather than later. This means you won’t miss out on any increased capital growth in the short term.
There are some ways to get around paying LMI…
- The most obvious way to avoid paying LMI is by having a home loan deposit of 20% or more, meaning you are borrowing 80% or less of the property purchase price. The 20% can come from savings, sale of other assets or even non-repayable gifts from parents wanting to help their kids get a head start on the property ladder.
- Having a security guarantor. Some first home buyers may have parents willing to offer the property they own as additional security to the loan to help reduce the LVR.
- Sometimes lenders have special promotions where they offer reduced or no LMI premiums to first home buyers and there are some government schemes available, however, sometimes they come with a number of hoops to jump through in order to qualify.
- There are some professions that various lenders deem low risk who may qualify for waived LMI, including doctors, pharmacists, dentists, accountants, lawyers and professional athletes.
So if you aren’t the greatest saver, don’t have access to the bank of mum and dad or aren’t a well known AFL star, it’s likely you will need to pay LMI to purchase your first home or upgrade to your dream home sooner. A specialist mortgage broker like Paul will be able to discuss with you your options based on your current circumstances and future goals, so you can make a well-informed decision on purchasing a property in LMI territory, bank speak for borrowing above 80% LVR.