What you need to know about lenders Mortgage Insurance
While requirements may differ from lender to lender, in general if you have to borrow 80% or more of the value of a residential property, your loan application and documentation will most probably require you pay the lenders mortgage insurance (LMI).
lender’s mortgage insurance is paid by the borrower, but protects the lender if you default on your home loan and your lender is required to sell your property.
If the property sells at a loss, the lender can make a claim against its LMI provider for the shortfall.
Paying lenders mortgage insurance allows borrowers with smaller deposits to buy earlier, rather than wait until they have saved up to the acceptable level of 20% of the deposit.
Get to understand the following points as one way to evaluate the benefits or otherwise of paying the lender’s mortgage insurance:
- LMI can be costly.
Borrowing 95% on a property worth $1,000,000 will result in a premium of around $42,275.
Borrowing 90% ($50,000 less) for the same price will result in a premium of around $22,320!
- Stamp duty and GST are payable on LMI Premiums, subject to state government rules.
- LMI is a one-off premium you pay. The amount is determined by your lender based on a number of factors including, but not limited to deposit size, loan size, and type of loan.
- You may be able to capitalise your LMI premium. This means adding the premium to your home loan amount and paying it as part of monthly repayments. However you will pay more as interest is payable on the LMI premium.
- LMI is not portable, which means if you want to refinance into a cheaper rate but are still borrowing in excess of 80% of the value, you will have to pay LMI again!
- Don’t confuse LMI with mortgage protection insurance, which you take out to cover loan repayments in the event you are unable to make payments because you’ve lost your job, been disabled, or worse.
Lenders mortgage insurance doesn’t protect the borrower, so who is covered by it and how does it work?
If borrowers default on their mortgage repayments, they’ll find themselves in a rather uncomfortable position that can result in their property being repossessed by the lender. The lender will then sell the property to recover the costs including the outstanding value of the loan, but what if this doesn’t cover their costs?
This is when the lender’s mortgage insurance or LMI comes into play.
If the defaulted mortgage is insured by an LMI policy, the mortgage insurer will pay the lender any outstanding not recovered by the sale of the property.
Although designed with the lender in mind, the product has helped borrowers – both homebuyers and investors alike by allowing loans with loan-to-value ratios (LVR) that are higher than the traditionally accepted 80% mark.
The fine print
When the time comes to have your loan approved by your lender, they may be able to approve the finance and authorise any necessary LMI policy up to a certain risk amount. However once your portfolio exceeds this amount, the lender’s mortgage insurance provider will make the decision on whether to accept the risk.
You could find yourself in the situation where, even though your finance provider is prepared to lend you the money with insurance, the mortgage insurer could reject the loan!
You just can’t win!