Lender’s Mortgage Insurance (LMI) is an insurance policy that protects the lender in case the borrower defaults on their home loan. If the borrower is unable to repay the loan, LMI covers the lender’s losses, ensuring they can recover part of the outstanding amount. It’s typically required when the borrower’s deposit is less than 20% of the property’s purchase price, which is common for first-time homebuyers.
Why Do Lenders Require LMI?
LMI is designed to protect the lender, not the borrower, from the risk of loss if the borrower fails to meet the repayment terms. When a borrower’s deposit is less than 20%, the lender’s risk increases, as there’s a smaller equity buffer to fall back on if the borrower defaults. In such cases, LMI serves as a safety net for the lender. The borrower, however, is the one who bears the cost of the insurance.
How Much Does LMI Cost?
The cost of LMI varies depending on several factors:
- Loan amount: The larger the loan, the higher the premium.
- Deposit size: The smaller the deposit, the higher the LMI cost. A 5% deposit usually results in a higher premium compared to a 10% or 15% deposit.
- Loan-to-Value Ratio (LVR): The higher the LVR (i.e., the higher the loan compared to the property value), the higher the cost of LMI.
On average, LMI costs between 0.5% and 3% of the loan amount. For example, on a $500,000 loan, LMI could range from $2,500 to $15,000. In some cases, the cost may be added to the loan itself, meaning the borrower ends up paying interest on the LMI premium over time.
How to Avoid LMI
While LMI is common for homebuyers with smaller deposits, there are several ways to avoid paying it:
- Save a Larger Deposit
- The most straightforward way to avoid LMI is to save at least a 20% deposit. A 20% deposit reduces the risk for the lender and eliminates the need for LMI. While this requires more time and effort, it’s the most cost-effective way to avoid the added expense.
- First Home Buyer Schemes
- The Australian government offers various schemes to help first-time homebuyers reduce or eliminate the need for LMI. For example, the First Home Loan Deposit Scheme (FHLDS) allows eligible first-time buyers to purchase a home with a deposit as low as 5%, with the government acting as a guarantor for up to 15% of the loan. This eliminates the need for LMI, as the lender’s risk is mitigated by the government guarantee.
- Guarantor Loan
- If you have a family member who owns property, they may be able to act as a guarantor for your loan. In this case, the guarantor’s property is used as additional security for the loan, reducing the lender’s risk and allowing you to avoid LMI. This is a common strategy for those who have family support but cannot afford a 20% deposit.
- LMI Waivers for Certain Lenders
- Some lenders may offer LMI waivers for borrowers with smaller deposits, typically through special programs for professionals like doctors, lawyers, or accountants. These programs often have stricter eligibility criteria but can allow you to borrow more than 80% of the property’s value without paying LMI.
- Use the Family Home as Security
- If your parents or relatives own their home outright, they may be able to use their property as security for your loan, allowing you to avoid paying LMI. This option is similar to a guarantor loan but typically requires the family member to have enough equity in their property.
Conclusion
Lender’s Mortgage Insurance (LMI) can be a significant additional cost for homebuyers with small deposits, but there are ways to avoid it. The most effective way is to save a 20% deposit, but for those who cannot, government schemes, guarantor loans, and lender-specific programs can provide alternatives. It’s important to assess your financial situation and explore all available options to minimize the cost of entering the property market.