March 19, 2015
Mortgage insurance is an insurance policy that compensates lenders for losses due to the default of a mortgage loan. Mortgage insurance works in the reverse of how we consider normal insurance should work. We usually take out insurance to protect ourselves – in case we have a car accident or our home is burgled, for example. We pay premiums every month to financially shield ourselves from the potential of something going wrong and it costing us bucket loads to fix it.
Mortgage insurance (often referred to as lender’s mortgage insurance or LMI) is a sum you pay to your bank or other lender to protect them. In reality, it offers you no protection at all. It protects the lender in case you default on your loan repayments.
For most lenders, mortgage insurance will need to be paid if you want to borrow more than 80 per cent of the value of the property you want to purchase. In the past, many lenders would allow you to borrow up to 100 per cent of the value (sometimes more when you included transactions costs) but those opportunities seem to have disappeared now. The most a bank will lend you these days is around 98 to 99 per cent (95 per cent plus approximately 3–4 per cent in mortgage insurance, which the bank adds to your loan).
Mortgage insurance protects the lender against the default of higher risk loans. In the lenders eye, a high-risk loan is one where the LVR is above 80 per cent. There may be one or two lenders that buck that trend to win your mortgage business, and offer 85 per cent with no mortgage insurance, but this is very much the minority.
If your deposit is small (5–20 per cent) you will most likely have to pay mortgage insurance, but this can actually work in your favour. Only contributing a 5 or 10 per cent deposit on new investment purchases (and therefore paying mortgage insurance) will make your leverage loan funds last much longer. Implementing this strategy will allow you to have more deposits available to buy more investment properties. Paying mortgage insurance is a small cost to bear to enable you to buy more properties sooner.
Here’s another reason why I say embrace mortgage insurance: it allows you to borrow a large amount of money with a very little deposit, making the chance to buy investment properties more accessible. Yes, it will cost you some extra money, but it means you can afford properties that you otherwise wouldn’t be able to and, once capital growth is realised, it will pay for itself. In the long run, with a well-chosen property, mortgage insurance is definitely a worthwhile cost to bear.
Mortgage insurance premiums vary according to the amount borrowed and the size of your deposit. It is charged on a sliding scale of up to 0 to 4.3 per cent of the purchase price and is levied as a one-off insurance premium at the time of settlement. You can pay the fee upfront or many lenders allow you to package up the cost of the insurance into your loan.
Mortgage insurance premiums are calculated on the insured loan amount, multiplied by the insurer’s rate (expressed as a percentage), at the applicable LVR (see Table 5.4 under step 10 for a sample of mortgage insurance premiums).
Mortgage insurance is tax deductible over five years.
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