How Does Lenders Mortgage Insurance (LMI) Compare To Rent-to-Own?

Which is better? Purchasing with LMI or using a rent-to-own provider?

Home Ownership
Guides
by
Dawn Teh

Most lenders require a deposit of at least 20% of the home's value to secure a mortgage. 

This can be a challenge for many first home buyers when you're juggling rising rentals and daily cost of living — which are all increasing at a faster rate than incomes. 

According to a 2022 report by Corelogic (a property analytics service), the amount of time needed to save for the 20% deposit of an average Australian home is now 11.5 years. 

It goes without saying that more are feeling like they're being priced out of the property market altogether. 

But what many aren't aware of is that there are (legitimate!) ways to buy your own home without the 20% deposit hurdle. 

In this article, we compare two of these options: Buying and paying lenders mortgage insurance (LMI) versus rent-to-own schemes.

Both allow you to start climbing the real estate ladder sooner. But they each have their pros and cons. So keep reading to discover your options and which is better for your situation.

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) 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).

Quick Comparison: Rent-to-own with OwnHome vs. Buy and Pay LMI

OwnHome (Rent-to-own) Purchasing and paying LMI
Move into your home now Yes Yes
Upfront costs 3% of the purchase price

(1% of this goes to your security deposit)
5-10% deposit
Lenders mortgage insurance
Stamp duty
Conveyancing costs
Other administrative fees
Build up a security deposit while you stay About 35% of your rent goes to your security deposit

(security deposit is deducted from the final purchase price)
NIL
Fixed purchase price Yes Yes
Ongoing payments Fortnightly
payments that cover your rent and security deposit
Monthly loan repayments
When is the home in your name When you choose to buy back your property from OwnHome, 2-7 years after the start of the agreement Immediately
Property buyback costs Same as securing a home loan There is no need to "buy back" your property

What is Lenders Mortgage Insurance (LMI) in Australia? 

LMI is basically insurance that protects the lender if you default on your loan. It's designed to help them recoup some of their losses if they have to sell your property to repay the loan.

Remember, LMI doesn't protect you — it only protects the lender. So, if you're having difficulties making your mortgage repayments, LMI won't help you stay in your home.

When do you need to pay LMI to secure a home loan? 

In short, you need to buy LMI premium if you're placing a smaller deposit for your home loan that is less than 20% of the property's value (i.e. you're borrowing more than 80%). Such loans are also called 5% (to 10%) deposit home loans. 

Example
You plan on buying a house that costs $500,000. If you're taking out a $450,000 loan amount (90% of the property value), you need to pay LMI.

However, if you're borrowing $400,000 (80% of the property value), you won't need to pay LMI.

Why have lenders chosen 20% as a cutoff? It mostly comes down to a calculation called the loan-to-value ratio (LVR).

The LVR is the amount of money you're borrowing, compared to the value of the property. The LVR is expressed as a percentage. For example, if you're buying a $400,000 house and taking out a $200,000 loan, your LVR would be 50%. 

By increasing your LVR with a bigger loan and a low deposit, the lender is increasing its risk. This is why they need you to purchase LMI to protect them from this risk. It also means you're more likely to pay a higher interest rate on your loan. 

Additionally, LMI payments vary with different lenders. You can usually do a lump sum upfront payment, while others may work it in as an added charge to your loan (bear in mind this will incur interest). 

Key Term
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.

How much is LMI usually?

The cost of LMI depends on multiple factors including the property value, deposit amount, and LVR. 

At the time of writing, the Genworth (a leading LMI provider) LMI calculator estimates that you might pay about $14,000 in LMI for a $500,000 property with a 5% ($50,000) deposit. 

What are the benefits of buying property with LMI?

The biggest benefit of taking a bigger loan and paying for LMI is that it allows borrowers with a limited down payment to obtain financing. This means you get to start being a homeowner and enter the housing market sooner!

What are the disadvantages of buying property with LMI?

LMI (which can be in the tens of thousands) is an additional cost and increases the overall amount you're paying for your property. The interest rates that lenders charge on such loans are also usually higher. 

Can LMI be waived? 

People from certain professions are eligible for an LMI waiver. This includes doctors, accountants, lawyers, and mining engineers. Talk to your lender to find out which professions qualify. 

The Australian government also has an initiative called the First Home Guarantee (FHBG) which was previously called the First Home Loan Deposit Scheme (FHLDS).

This initiative allows purchasers to buy a house with as little as a 5% down payment (and you get an LMI exemption). The government basically guarantees the remaining 15% of the usual 20% deposit that lenders require — which is how LMI is avoided. 

However, this initiative is not available to everyone (just 35,000 spots are available each year!). Plus, to qualify for the program, applicants need to be Australian citizens, intend to be owner occupiers of the home, and more.   

Is LMI worth avoiding?

Whether it's worth avoiding LMI depends on your circumstance. 

You're likely to get your home loan application approved faster than if you followed the route of renting and saving for a larger deposit of 20%.

If you're eyeing an area where house prices are increasing rapidly, securing a loan sooner and paying LMI might help you counter price inflation. 

However, it can add significantly to the total amount you're paying for a new home (it's around $14,000 for a $500,000 home). And remember, you're also more likely to pay higher loan repayments because of increased interest rates compared to a traditional home loan. 

An alternative to a 5% deposit home loan (with LMI) is the rent-to-own model. It also offers a faster path to homeownership with potentially lower upfront costs. 

What is rent-to-own?

Rent-to-own is a type of housing agreement where you agree to rent a property for a set period of time, with the option to buy it at the end of the lease. 

You'll typically pay a rental premium on top of your regular rent, which goes towards the property's purchase price. 

This is the general way that most rent-to-own structures work. But there can be significant differences depending on the service provider.

Here’s a more in-depth look at our rent-to-own program at OwnHome:

How does OwnHome's rent-to-own pathway work?

At OwnHome, we offer a rent-to-own pathway for first time home buyers to quicken the process of living in their dream home. OwnHome is backed by the Commonwealth Bank.

Here’s how it works:

  1. Choose your dream home and OwnHome will buy it in OwnHome’s name. You can move in straight away without saving for a 20% home deposit. Upfront costs are just 3%, with 1% going to your Security Deposit. (You also get access to our team of home experts to help you navigate the home buying process). 
  2. Pay fortnightly rent to OwnHome with part of this sum going towards your Security Deposit (which can be used when you buy back the home, and comes off the purchase price). Think of this as saving up for the deposit while you’re living in it. 
  3. Buy your home after 2-7 years from the start of your agreement with OwnHome at the pre-agreed price. (If the true market value of your home increases above OwnHome's set purchase price, you get to keep the upside!)
Example

OwnHome purchases your dream home for $1,000,000. You start living in it and pay fortnightly rent to OwnHome. Part of this payment goes towards your security deposit (which you can use to buy back your property from OwnHome).

The property's value will increase each year at a pre-agreed fixed rate. Between 2-7 years after the start of your agreement with OwnHome, you can choose to buy your property.

Let's say after 5 years, the property purchase price has increased at the fixed rate to $1,200,000 and you've contributed $150,000 towards your Security Deposit. You will only need to secure financing for $1,050,000 if you choose to buy the property.

If the home's true market value has grown above OwnHome's pre-set price, you keep the upside. Let's say the OwnHome price is $1,200,000, but the home would be valued on the market for $1,400,000, you keep the $200,000.

This means your equity in the home is equivalent to $350,000: the $150,000 security deposit, and the $200,000 capital gains. Therefore, you'll need to secure $1,050,000 of financing with an LVR of 75%.
Key Term
Security Deposit

Your "Security Deposit" is the amount of money you've accumulated through your fortnightly payments to OwnHome. About 35% of your fortnightly payments is contributed to your security deposit.

The security deposit will be deducted from your home's final price when you buy it from OwnHome.

Is rent-to-own legal in Australia?

The government policies surrounding rent-to-own vary from state to state in Australia as it's a relatively new pathway to home ownership. 

Currently, OwnHome legally services these areas: Greater Metropolitan Sydney, Wollongong, Newcastle, Brisbane, and the Gold Coast.

What good about renting-to-own with OwnHome?

Here's a look at what's good about OwnHome's rent-to-own pathway:

  • You won't need to save for a 20% home deposit — the upfront cost is 3% of the property's value, and 1% of it goes to your security deposit! 
  • No LMI needed.
  • Start living in your dream home immediately, perform renovations and make it yours.
  • Build up your security deposit while staying in your dream home — with each fortnightly payment, about 35% is contributed towards your security deposit. 
  • You don’t need to involve family members or loved ones in purchasing your home.
  • You get a dedicated home buying expert to help with negotiation, determining a fair price for the home, bidding, and the whole purchasing process.
  • Fixed purchase price when you choose to buy back your home from OwnHome.  
  • Potential capital gains — If your home valuation grows fast, you get to keep the capital gains above the pre-agreed price.
  • We ensure you get objective advice — We require that you seek independent advice before signing up with OwnHome.
  • OwnHome takes care of strata levies and some maintenance costs (while you're renting from us). 
  • We have a Hardship Policy where we do our best to explore options to help you if you're unable to make fortnightly payments. (e.g. reducing security deposit contribution). 

What are the disadvantages of rent-to-own with OwnHome? 

Rent-to-own property schemes can be a great way to get on the property ladder, but there are some disadvantages to be aware of. 

  • There’s a one-off 3% upfront fee. However, this is still less than the 5% deposit and LMI fee in a 5% deposit home loan. Plus, 1% of OwnHome's 3% fee goes to your security deposit which you can use when buying back your home.
  • Full ownership is delayed — The home will only be in your name when you repurchase it from OwnHome.
  • The value of your home might drop lower than the pre-agreed purchase price (but you can walk away, unlike a mortgage).
  • We do not service those looking to buy an investment property. 

Beware! Not all rent-to-own programs are the same

When it comes to rent-to-own schemes in Australia, remember that not all are the same as OwnHome and it's important to read the fine print in your agreement! 

Some key things to look out for include:

  • Is the initial property value over-priced to begin with?
  • When you decide to buy back your home, is the property purchase price fixed or variable?
  • Other hidden costs — Is the buyer or landlord responsible for maintenance fees, repairs, strata levies, etc.?  
  • Are there safety nets in the event you miss a payment?

Can you still use the first home owner grant with OwnHome? 

Opting for OwnHome's pathway to home ownership doesn't disqualify you from the first home owner grant. So you should be able to use it when you repurchase your property from OwnHome (as long as you satisfy other conditions of the grant). 

Is OwnHome right for you?

You might want to consider OwnHome's rent-to-own program if:

  • You're having difficulties getting approved for a traditional home loan. 
  • You need some help saving up for a home deposit. 
  • You don't have access to the bank of mum and dad.
  • You want to have an edge when bidding for your dream home (OwnHome can make an all-cash offer). 

Should you buy and pay LMI or rent-to-own? 

Whether rent-to-own or buying and paying LMI is better for you depends on your individual circumstance. 

Both offer an alternative to the traditional mortgage with a 20% deposit and a faster pathway to home ownership.

However, some of the key differences include upfront costs. With a 5% deposit with LMI, you still have to come up with 5% of the property value and pay LMI on top of that. 

With OwnHome's rent-to-own pathway, you only pay 3% of the upfront cost — with 1% of this going to your security deposit (which can be used to buy back your property from OwnHome down the road). 

Ultimately, each home buyer's circumstances are unique. So it's important to do your own homework based on your clear personal needs and goals. 

Talk to an expert (we're here to help!) and get as much information as possible to make an informed choice.

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

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