Complete Guide to Lenders Mortgage Insurance in Australia (And How To Avoid It)

If you're in the process of looking to buy a new home, you might have come across the term Lenders Mortgage Insurance (LMI) and wondered what it's all about.

Home Ownership
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by
Dawn Teh

If you're in the process of looking to buy a new home, you might have come across the term Lenders Mortgage Insurance (LMI) and wondered what it's all about.

As a quick answer, LMI is an insurance that protects the lender in case you default on your mortgage. It's paid by the borrower and is usually required when the size of your deposit is less than 20% of the purchase price.

But before you go ahead and pay this insurance, you need to be aware that there are a couple of ways you might be able to avoid it!

So keep reading to discover all about LMI and the low-deposit alternatives to buying a property without paying this extra cost.

Disclaimer: This article is intended to be general in nature and is not personal financial product advice. It does not take into account your objectives, financial situation, or needs. In particular, you should seek independent financial advice and read the relevant product disclosure statement (PDS), target market determination (TMD), or other offer documents before making an investment decision in relation to a financial product (including a decision about whether to acquire or continue to hold).

What is Lenders Mortgage Insurance?

Lenders mortgage insurance (LMI) is insurance that protects lenders against loss if a borrower defaults on a home loan. 

It's usually a one-off payment to be paid on settlement day. It may be required whether it's your first home purchase or looking to refinance. 

Remember, it benefits the lender and not the borrower.

When is lenders mortgage insurance (LMI) needed?

LMI is usually needed when the borrower puts down a deposit that's less than 20% of the property's value.

Here's why...

When you take out a mortgage in Australia, most lenders typically require a 20% deposit, allowing you to borrow 80% of the property's value. 

Bear in mind that the exact percentage may vary as every financial institution or bank has its own lending criteria.

If you put down a deposit of less than 20%, this increases the amount of money you'll be borrowing from the lender.

From their perspective, this makes it a riskier loan for them to approve.

To reduce this risk, they require the borrower to purchase LMI. In the event that the borrower is not able to pay back the loan, the lender can make a claim on the LMI policy to cover the debt.

Different lenders decide whether LMI is needed based on a calculation called the loan-to-value ratio (LVR).

To determine your LVR, simply take the amount you're borrowing and divide it by the value of the property.

If your LVR is above 80%, that's usually when your lender will need you to purchase LMI so they can approve your loan.

Key Terms
Loan-to-value ratio (LVR)
The LVR is the loan value divided by the value of the property you're buying. The higher the LVR, the riskier the loan is to the lender. This means that the interest rates they offer will also likely be higher.

Example of how lenders mortgage insurance (LMI) works

Let's assume you want to buy a home that costs $500,000.

Typically, you'd need to come up with a 20% deposit ($100,000) to borrow $400,000 from the lender. In this case, you won't have to pay LMI.

However, if you can only come up with a 10% deposit ($50,000), the lender might still loan you $450,000 if you purchase LMI.

Let's say that you chose the LMI option and a few years later, you default on your loan. There's still $300,000 owing on your property. But the lender only managed to sell the property for $250,000.

This means there's still a $50,000 shortfall which the lender will try to claim from the LMI provider.

What's good and bad about lenders mortgage insurance (LMI)?

The most obvious benefit of LMI is that you can get your loan application approved sooner without waiting to save up for the full 20% deposit.

The bad news about LMI is that it can be pretty expensive so it will add to the overall cost of purchasing the property. 

In some cases, the interest rates on loans with a smaller deposit may also not be as competitive as a regular loan with a 20% deposit.

How much does lenders mortgage insurance LMI cost?

The exact cost of LMI premiums varies greatly as it depends on the LVR and total loan amount.

To give you an estimate, LMI would cost about $12,000 for a $500,000 home with a $50,000 deposit.

How is lenders mortgage insurance premium calculated?

The LMI fee is usually based on your LVR and the amount you intend to borrow. This applies whether you're buying your first home or refinancing. 

The more you borrow, the higher your LVR, which means your LMI costs will go up as well.

The total cost should also include stamp duty and GST. 

To determine the value of your property to calculate the LVR, the lender might conduct its own property valuation by doing an in-person inspection. 

They may also search online for recent information about the sale price of similar properties in the area to determine a value.

What's the difference between lenders mortgage insurance (LMI) vs mortgage protection insurance

You might have also come across the term "mortgage protection insurance" (sometimes called home loan insurance) before.

It's not the same thing as LMI! So don't get mixed up.

While both are paid by the borrower, LMI benefits the lender while mortgage protection insurance protects the borrower.

If you buy LMI and happen to default on your loan down the line, the insurance payout goes to the lender.

On the other hand, mortgage protection insurance helps the borrower to pay off the home loan in the unfortunate event that the insured is unable to continue working. This can be due to events like illness, injury, or death. 

It's an optional insurance policy that you may or may not choose to purchase.

In Australia, there are a number of different providers of mortgage protection insurance, so it is important to compare policies before buying.

Make sure you understand the coverages and benefits of each policy before making a decision.

Mortgage protection insurance can be an important part of financial planning, especially if you have a family that relies on your income. This can give you and your family the security of knowing that your home is safe in the event you can't work anymore.

Remember:

  • LMI protects the lender
  • Mortgage protection insurance protects the borrower

LMI waiver for eligible professionals

Yes, some professionals might be eligible for an LMI fee waiver because their jobs are usually stable and high-paying.

Professions on the list include doctors, lawyers, accountants, and mining engineers. Speak to your lender or an LMI provider to learn more about which professions qualify. 

Other low deposit borrowing and buying options

Before you jump straight into paying LMI, there are actually other options for buying a home with low- to no- deposit you should be aware of:

  • LMI vs Guarantor Loan

A guarantor loan is one of the most ideal choices for those that are having difficulties saving up for a 20% deposit.

In this scenario, a guarantor (usually a closely-related family member) puts up part of their own home equity as a security for your loan. This means you can come up with a smaller deposit (sometimes no deposit at all) and avoid LMI altogether.

However, if you stop making loan repayments, the portion of home equity which has been pledged by your guarantor will be at risk.

The biggest issue with a guarantor loan is that you're putting added financial risk on a loved one. This can result in relational strains — especially if you can't make mortgage repayments.

  • LMI vs First Home Guarantee Scheme

The Australian government has launched the First Home Guarantee (FHBG) which lets first home buyers purchase their home with a deposit of as small as 5% without paying LMI.

It was previously called First Home Loan Deposit Scheme (FHLDS).

The government basically acts as a guarantor for the remaining 15% of the deposit that lenders require, which is why LMI can be avoided. 

The issue with the FHBG is that there are only 35,000 spots available each year! 

Plus, there are other criteria applicants need to fulfil in order to qualify. This includes being an Australian citizen and there are also income caps.   

  • LMI vs Rent-to-Own

OwnHome's rent-to-own program is a new pathway to homeownership that only requires a 3% deposit for home buyers to get started. (The application process is free too!)

Here's how it works:

  1. OwnHome buys your dream home. The upfront cost is just 3% of the property value — that's it.
  2. You continue renting and living in your dream home. Part of your fortnightly payments also goes to a security deposit and you can start living like a homeowner. 
  3. You buy back your home after 2-7 years at a pre-agreed price. The security deposit you've built up over the years can go towards your purchase.

The main benefit of OwnHome is that the upfront costs are lower than buying with LMI. Plus, you get to start living in your dream home immediately. 

But unlike buying and paying LMI, you don't actually own the property until you buy it back a few years later.  

Also, beware that there are other rent-to-own programs out there with different terms than what OwnHome offers.

So read the terms carefully before committing to anything.

Use this calculator to find out how much you'd save with OwnHome compared to renting and saving.

Discover Your Buying Power With OwnHome

  • LMI vs saving up a 20% deposit

The benefit of LMI is that it allows you to enter the property market sooner. But adds to the overall cost of your property.

Saving up for a bigger deposit (usually 20%) can take a lot longer, but reduces your overall cost.

However, bear in mind that time is money in a sense too. If you're eyeing an area with rapidly increasing property prices, the 20% deposit amount will keep growing too — making it harder for buyers to get their foot in the door.

In such cases, it might be beneficial to get into the market earlier.

Is buying and paying LMI right for you?

Whether LMI is right for you depends on your circumstances and personal objectives.

The 3 main things you have to consider are:

  • How much of a deposit you have you already saved up.
  • How much you're willing to pay in interest and fees? Remember as your LVR goes up, so does your LMI premium.
  • How quickly do you want to buy a property? Are property prices rising fast in the area you're eyeing? Do you have time to wait or does your family situation require a home as quickly as possible?

If you're not sure, speak to a financial adviser who can help you weigh up the pros and cons of buying a property with a smaller deposit and purchasing LMI.

Also, remember that LMI is not the only low-deposit home buying option available. At OwnHome, we specialise in offering a rent-to-own pathway to home buyers that only requires a 3% upfront fee.

You can use our calculator below to find out how much you'd save with OwnHome compared to renting and saving.

Discover Your Buying Power With OwnHome

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