Lenders mortgage insurance, or LMI, is one of several fees you may encounter on your journey to home ownership, but unlike some others, it’s one you can avoid in certain circumstances.
LMI is only required when the deposit is less than 20% of the price. Although the cost of LMI is paid by the owner, its coverage protects the lender.
» MORE: What is stamp duty on a house?
What is lenders mortgage insurance?
LMI is insurance that your lender takes out to insure themselves if you default on loan repayments and the property ends up being sold for less than the outstanding amount on the mortgage.
Let’s say, for example, you bought a property for $400,000 but after three years you cannot pay the mortgage and the lender is forced to sell. If the property’s value has fallen to $300,000 with $370,000 still owed on the mortgage, LMI will make up the $70,000 difference. As such, LMI is protection for the lender, so as the borrower you can never make a claim on it.
LMI is also distinct from other types of insurance, such as home and contents, title insurance insurance or disability/work-related insurance, which may allow you to continue paying your mortgage even if you lose your job.
How does LMI work?
LMI consists of a one-off, upfront payment, which becomes payable when a borrower has a deposit that’s less than 20% of the home’s price. The borrower pays the fee to the lender at settlement time who then pays the insurer and the policy is good for the life of the mortgage, regardless of its length.
Any fees the insurer charges the bank will then be passed on to you, the purchaser, that you can pay in full at the outset as part of the overall fee or added to your mortgage repayments. It’s advisable, however, to talk to a mortgage broker or financial adviser about the best payment options.
How LMI costs are calculated
Lenders charge different rates for LMI and most mortgage providers have calculators on their websites, which you can use to compare rates when you’re shopping around for the best loan. LMI also comes with a stamp duty fee that differs from state to state and is currently 9% in NSW and 10% in Victoria, for example.
To understand how much an LMI policy will cost you, simply key in the cost of the property and the deposit amount you have to put towards it. If, for example, you’re buying a property for $400,000 in Victoria but you only have a 10% deposit to put towards it and need to borrow the other $360,000 (90% of the property’s value) over a 20-year mortgage term, an LMI policy from Westpac would cost you $8790.
The more expensive the property and the less the deposit the higher the LMI fee is going to be. So if you are looking to buy a $600,000 property in Victoria over 20 years with only a 5% deposit ($30,000) and you need to borrow the other $570,000, the fee Westpac charges for LMI has jumped to $25,951.
Pros and cons of LMI
On the plus side of the ledger, LMI does allow people to buy properties that might otherwise be out of reach. Despite meeting your lender’s other prerequisites, such as stable employment and a good credit score you might just not be able to muster the required 20% deposit and FOMO (fear of missing out) can be a major driver in a red-hot property market where everyone’s diving in head-first.
When the market is buoyant this strategy can well and truly pay off, too. For example, if you’d bought the aforementioned $400,000 property five years ago with a 10% deposit and the property is now worth $700,000, you’d be a long way ahead given the LMI cost you less than $9000.
Having said that, house prices in Australia’s capital cities have been falling steadily throughout 2022 with only Darwin bucking the trend, thanks to interest rates rising relentlessly and ongoing global economic uncertainty. Under these circumstances, taking out an LMI policy now to buy a property instead of saving for a larger deposit seems counterintuitive.
Also, on the downside, it’s important to note that, as the property’s purchaser, you get no protection from LMI in a worst-case scenario, where your lender ends up selling your property because you can’t make repayments or resolve the issue any other way.
Once the lender sells the property and there’s still say $50,000 owing on the loan –and it could be more if the market has taken a major downturn – the insurer will pay the lender that amount but then seek to retrieve the money from you. While most lenders will work with you as diligently as possible to avoid this situation, it does happen, especially during economic downturns.
Frequently asked questions about LMI
Yes, lenders mortgage insurance can be claimed as a tax deduction as a borrowing expense, according to the Australian Taxation Office website.
Lenders mortgage insurance is required when making a deposit that’s less than 20% of the home’s purchase price. To avoid LMI, you’ll need to make a deposit of 20% or more.