Buying a home with little to no deposit can be an appealing option for many Australians, but it often comes with a catch — Lender’s Mortgage Insurance (LMI). LMI is usually required when borrowers have a deposit less than 20% of the property’s value. While it can help you secure a home loan with minimal savings, it’s important to understand what LMI is and how it affects your financial journey. Here’s what you need to know.
What is Lender’s Mortgage Insurance (LMI)?
LMI is an insurance policy that protects the lender, not the borrower, in case the borrower defaults on their loan. When you borrow more than 80% of the property’s value, the lender considers the loan riskier. To mitigate this risk, they require LMI as a safeguard. The insurance covers the lender’s losses if you can’t repay the loan.
Why Do You Need LMI?
LMI is typically needed when the Loan-to-Value Ratio (LVR) is above 80%. LVR is the percentage of the property’s value that you are borrowing. For example, if you’re buying a $500,000 home with a 5% deposit ($25,000), your LVR would be 95%, and you would need LMI.
The reason for LMI is simple: if you default on your loan and the sale of the property doesn’t cover the full outstanding debt, the insurer will compensate the lender. This reduces the lender’s financial risk, allowing them to offer you a loan with a lower deposit.
How Much Does LMI Cost?
The cost of LMI varies based on several factors:
- Loan amount: The larger the loan, the higher the premium.
- Deposit size: A smaller deposit leads to a higher LMI premium.
- Loan-to-Value Ratio (LVR): A higher LVR increases the risk to the lender, thus increasing the LMI cost.
On average, LMI can cost between 0.5% and 3% of the loan amount. For example, for a $500,000 loan, the cost of LMI could range from $2,500 to $15,000, depending on the LVR and loan amount.
Who Pays for LMI?
In most cases, the borrower pays for LMI, even though the insurance protects the lender. LMI can either be paid upfront or added to the loan amount. If added to the loan, you’ll pay interest on the LMI premium, which means you’ll end up paying more over the life of the loan.
Can You Avoid LMI?
While LMI is often unavoidable with low deposit loans, there are ways to bypass it:
- Save a Larger Deposit: If you can save at least 20% of the property’s value for a deposit, you won’t need to pay LMI. This is the most straightforward way to avoid the extra cost.
- Use the First Home Loan Deposit Scheme (FHLDS): If you’re a first-time homebuyer, the government’s First Home Loan Deposit Scheme allows you to purchase a home with a deposit as low as 5%, and the government acts as a guarantor for the loan, meaning you don’t have to pay LMI.
- Guarantor Loans: If a family member has significant equity in their property, they may be able to act as a guarantor for your loan, allowing you to borrow the full amount without LMI.
- Professional Packages: Some lenders offer special programs for professionals, like doctors or lawyers, that allow them to purchase a home with no deposit and avoid LMI. However, these packages typically come with higher eligibility requirements.
- Shared Equity Schemes: Some states and territories offer shared equity schemes, where the government or a private investor helps fund a portion of your deposit. This reduces your borrowing amount, potentially eliminating the need for LMI.
Conclusion
While Lender’s Mortgage Insurance can make it possible to buy a home with a smaller deposit, it comes at a cost. It’s important to weigh the pros and cons of purchasing a home with LMI and explore alternatives like government schemes or guarantor loans that may help you avoid this extra expense. By understanding how LMI works and considering your options, you can make a more informed decision about how to enter the property market with minimal financial strain.