July 18, 2014
As a home buyer, one of the terms that you may come across is Lenders Mortgage Insurance (LMI). This is a cost added to your loan when you borrow a large percentage of your home’s value.
The insurance is required to protect the lender in case you default on your home loan payments.
It is a one-off cost that is paid when the loan is taken out and covers the term of the loan. Generally, you will need to pay LMI when you borrow more than 80 per cent of the property's value.
For example a loan of $360,000 using a property valued at $400,000 is a 90% loan and LMI will apply. The cost will vary between different lenders and is normally added to the loan.
Many home buyers are willing to pay this to obtain a foothold into the property market more quickly. The alternative to paying the premium is to keep saving for a larger deposit, but this method can be challenging, if time and inflation factors erodes the buying power of your savings.
There is critical debate about the cost imposition of this strategy and quite often the home buyer is usually left quite vague about what LMI is all about. The main areas of concern include:
Confusion about who is protected
A common mistake by the home buyer is thinking that LMI covers them and is often confused with Mortgage Insurance. So let’s be clear:
• LMI covers the lender. The agreement in place is between then lender and the insurer and protects the lender when the loan goes into default and a mortgagee sale arises. If the sale of the property does not fully cover the outstanding loan then the lender will claim on their insurance to recover the shortfall.
• Of critical importance, even if the lender receives the shortfall, the insurer will generally pursue the home buyer for the difference. In effect you could be paying twice.
• Mortgage Protection Insurance is an optional insurance that the borrower takes out themselves to protect them or their family if a death or insurable medical and/or injury causes them to not be able to meet their financial obligations.
Barrier to Switching
LMI is really a sunken cost and when the borrower looks to refinance afterwards they then find out that the LMI paid is not transferrable. This becomes a barrier to having freedom to consider another lender, if the borrower is seeking a more competitive interest rate or different product
If the refinance results in another lend that is more than 80% then another premium has to be paid with that new lender. Of course overtime a property may have increased in value so that the borrowing percentage is under 80% and it is only then that the refinance to another lender would
not incur another LMI premium.
Knowing if a borrower has paid LMI in their loan is an important aspect for your mortgage broker to be aware of when assessing the overall value of switching to another lender.
Generally a borrower can get discount on a new LMI premium when they increase their loan or internally refinance to a new loan while staying with their current lender.
Can you get a rebate?
Think about this, what happens if the you come into some inheritance or other windfall and then able to pay out your loan before the loan term? are you entitled to any rebate on LMI? Unfortunately there is no obvious answer to this situation.
There are two major insurers in Australia, Genworth & QBE, and lenders have different individual agreements with them making is difficult to know how those arrangements would impact on your claim for a rebate.
Disclosure is not a strong point in the area so borrowers are left in the dark. According to a Genworth fact sheet consumers are advised to ‘know and avail themselves of existing refund programs already offered by the lenders in the first two years, and know when lenders have provided a discounted insurance premium in lieu of any refunds'.
These facts plus the barriers to switching can make the LMI insured loans a costly affair and rather confusing.
However 90% of first home buyers ( Genworth 2011) use this strategy to allow them to enter into the property market. Overall it enables home ownership for Australians who have less than 20% deposit and have capacity to meet their mortgage repayments.
So if you’re considering your mortgage options and LMI will be necessary it’s even more important to speak to our Mortgage Choice team. We do more than consider the sharpest interest rate; we also consider the varying LMI costs from 28 different lenders to ensure you make an informed decision about your chosen lender.
Call Julie Browne on 0421 206 543 today for more information about LMI and other mortgage questions