Can’t people just get along? Lenders Mortgage Insurance gets a bad rap but there are two sides to every coin. Let’s make heads the good side, and tails the dark side. But first a quick recap of what this is all about.
What is Lenders Mortgage Insurance?
LMI has been around since the late 1980’s. Its role is to help more people enter the market by helping them get loans. Up to that point lenders asked for a 20% deposit for a loan but people often found it hard to meet this target. LMI was born so that lenders had insurance for defaulted loans, while borrowers had a way to access loans with smaller deposits.
Heads (the good side)
You’ll hear the most cheering for LMI from actual LMI providers: the insurers themselves. And the banks. This is because LMI works for them and is meant to work for the economy. Banks get better ratings because of their insurance, while any large drops in property values don’t pose such a threat to the financial system. The two big providers in Australia are QBE and Genworth Financial. The big four banks (CVA, NAB, Westpac, ANZ) either use one of these two or self-insure.
The good side of LMI is that it helps you to enter the property market and grow your portfolio. Insurers figure the rate out by looking at your LVR, one more annoying acronym you need to know. This is your Loan to Value Ratio. If you want to buy a $500,000 property and you need to borrow $450,000 from a lender, the LVR is the percentage of what you need ($450,000) from the value ($500,000) of your property. 450,000 is 90% of 500,000 so the LVR is 90%. This is a high cost/higher risk LVR for your lender so the LMI (your insurance payment) will be larger as a result. The higher the LVR, the higher the LMI. OK, enough acronyms.
While you will hear a lot about avoiding LMI (such as this handy post), you may not always want to avoid it. Based on Genworth’s LMI calculator, you can expect to pay the following on a $500,000 property.
If the cost of the property is $500,000 then:
- 5% deposit: LMI cost = $15,960
- 10% deposit: LMI cost = $8,640
- 15% deposit: LMI cost = $4,803
If you can afford a 15% deposit, an LMI of $4,803 may not break the bank and you can often add this to your principal loan. When you factor in capital growth this may become a small cost for you to enter the market. If it is an investment property, you can also claim tax deductions for your LMI.
Tails (the dark side)
LMI does get a bad rap but this is not because of what it is but how it is used. Surveys have shown that a high number of borrowers think that LMI is to insure them rather than the banks. This makes sense because they pay the insurance and in any other situation when you pay insurance you expect it is for your benefit. This has led to some borrowers who, after defaulting on their mortgages and having their homes sold by the banks, have had to then pay their insurers for any leftover costs.
A lack of clarity from lenders to their borrowers has led to these issues. But the main reason you may want to avoid LMI is because of the cost and risk involved. If you can only afford a 5% deposit on your loan and you add the LMI (for a $500,000 loan = $15,960) then more often than not, you will add this to your principal loan. If you are in a financial position and point in your life where you can take on this sort of risk, great. But if it is a stretch to even make the 5% deposit, then taking on this sort of risk leaves you open to the effects any changes in your life (health, job loss, divorce) may have on your finances.
If you have looked at your finances and you want to put a smaller deposit on a property and take out LMI, be sure to compare. Different lenders will offer you different rates. It is worth both researching these and talking to your property adviser or financial adviser before making any decisions.