The short answer to whether you pay lenders mortgage insurance on a home loan with 5% deposit is: generally speaking, yes. However, the reality is a lot more complex than that, and there are many ways to avoid the significant costs of LMI. Find out more about the ins and outs of LMI on a low-deposit home loan below.
When it comes to buying a new home, there are so many things to keep in mind that lender’s mortgage insurance may slip your mind completely. If you’re new to the Australian property market or are a first-home buyer, it might even be a concept you’re unfamiliar with.
In fact, when it comes to buying a house, the property price is only the first cost to consider. Some of the upfront costs that follow are decided by the size of your house deposit, and how much money you borrow.
The recommended deposit on a home loan in Australia is 20% of the value of the property.
If your initial deposit is lower than 20% of the purchase price of the property — in this case, 5% — you will be required to pay LMI.
What is LMI? What is LVR?
LMI stands for lenders mortgage insurance, and you’ll see both terms used. It is a fee that is paid to provide insurance for your lender if you are paying a low deposit on your home loan, below the recommended 20% of the property value. This is why you will often hear LMI talked about in the same breath as LVR.
LVR stands for the loan-to-value ratio of your home loan. This means the loan amount as compared to the total home loan value and is often expressed as a percentage. If you have paid a 5% deposit, your LVR might be noted as 95%. If loan-to-value ratio is done in tiers, yours would be LVR 95 or similar.
What this means is that with an LVR >80, you will pay lenders mortgage insurance. There are, of course, ways to minimise the cost of LMI while paying a smaller deposit on your home loan.
The cost of LMI
LMI can be a significant cost, as it is charged in relation to the property value. The more expensive your property is, the more you’ll be paying. Though you can shop around with different providers, there doesn’t tend to be a huge deal of different in LMI premiums. You will also need to factor in other expenses like stamp duty and conveyancing.
As an example, if you were to buy a $600,000 home with a 5% deposit, you would be borrowing $570,000 (plus the interest that accumulates over the life of the loan). LMI would then need to be paid and, depending on your lender and your circumstances, would work out to somewhere around $25,000.
When you’re already making a major financial investment, that’s a big price to factor in. So it’s important to know the eligibility criteria for not paying LMI, and the alternatives to paying LMI (while keeping your loan amount lower).
Can I capitalise my LMI with a 5% deposit?
The most common way to pay LMI is to capitalise it, meaning the fee is just added to your loan amount. While this means you don’t need to pay a large lump sum upfront, you will have to pay interest on the LMI.
Generally speaking, most lenders have a maximum LVR they will accept, inclusive of capitalised LMI. So, if you’re looking for a 95% LVR loan with a 5% deposit, adding LMI to that loan amount will then take you over the maximum LVR. So, when dealing with very low-deposit home loans, lenders will often require the upfront payment instead.
Avoiding LMI with low-deposit home loans
Since low deposit home loans mean your lender is taking on extra risk as opposed to borrowers with 20% deposits or people looking to refinance who already have some equity, avoiding LMI is all about demonstrating your reliability as a borrower.
This is why your occupation might mean you could be exempt from paying LMI. If you work as a doctor, you may be able to borrow the full value of the property without paying LMI. In some circumstances, this may also apply to lawyers, solicitors, engineers, surveyors, geophysicists, accountants, auditors, actuaries and more. If you work in legal, mining, or finance professions, it may be worth enquiring about the eligibility criteria.
It is also why you do not have to pay LMI if you opt for a guarantor home loan.
With a guarantor home loan, a family member or close loved one is using the equity on their home as collateral on your loan. This minimises the risk for the lender, which is why you are able to borrow more money with a guarantor. As a disclaimer, this is also a significant risk for a family member/loved one to undertake, and can put stress on the relationship if you are unable to keep up with your home loan repayments.
If you receive a gifted deposit, you also won’t have to pay LMI. This is because it is a case where you have a smaller deposit and a loved one or family member gifts you the remaining deposit, so you will no longer be paying a 5% deposit. The lending criteria for a gifted deposit can be quite strict, so you will need to demonstrate proof of your ability as a saver by showing evidence of genuine savings.
The majority of people paying a low deposit will be first-home buyers, finding saving up for an upfront deposit challenging. In these cases (and some others!) there are federal government schemes available to help make this more accessible, and that may help you save on LMI.
Eligible first-home buyers may be able to use the first homeowners grant to top up their deposit, allowing them to make up the 20% required deposit. There are some restrictions on who can use this grant to keep in mind — it is only for owner-occupiers, and price caps may apply to the property values.
First-time buyers may also qualify for one of the federal government’s home guarantee schemes. There are several government schemes in effect, including one for regional home buyers and one for single parents (called the family home guarantee), but the largest is the first home guarantee (also called the first home loan deposit scheme or FHLDS).
This consists of a set number of homes allotted to Australian citizens who are first-home buyers with low-deposit home loans. These cannot be used on investment property purchases and are for owner-occupier purposes only.