If you’re planning to buy a home but don’t have enough deposit to put down, you may need to take out a home loan with Lenders Mortgage Insurance (LMI). In this article, we’ll explain what LMI is and how it works.
What is Lenders Mortgage Insurance?
LMI is an insurance policy that protects the lender in case the borrower defaults on their mortgage repayments. It’s generally required by lenders when the borrower has less than 20% deposit. The insurance premium is paid by the borrower and can be added to the total amount of the loan.
How Does LMI Work?
When a borrower takes out a home loan with less than 20% deposit, the lender may require them to take out LMI. The premium is calculated based on the size of the loan and the deposit amount. The higher the loan-to-value ratio (LVR), the higher the premium.
For example, if you’re buying a home for $500,000 and have a deposit of $50,000 (10% deposit), your LVR would be 90%. The lender may require you to take out LMI, which could cost around $7,500. This premium can be added to your mortgage, which means you’ll be paying interest on it over the life of the loan.
Why Do Lenders Require LMI?
LMI protects the lender in case the borrower defaults on their mortgage repayments. If the borrower is unable to make their repayments, the lender can sell the property to recover their losses. However, if the sale price is less than the outstanding loan balance, LMI can help cover the difference.
Without LMI, lenders would be more reluctant to lend to borrowers with less than 20% deposit, as the risk of default is higher. LMI gives lenders greater confidence to lend to these borrowers, which can help more people get into the property market.
How is LMI Calculated?
LMI is calculated based on the size of the loan and the deposit amount. The higher the LVR, the higher the premium. Other factors that may affect the premium include the borrower’s credit history, employment status, and income.
The premium can be paid upfront or added to the total amount of the loan. If it’s added to the loan, the borrower will be paying interest on it over the life of the loan.
How Long Do You Need to Pay LMI?
The premium for LMI is paid upfront or added to the loan amount, but it doesn’t last for the entire life of the loan. The premium is usually amortised over the first few years of the loan, typically up to five years.
After the LMI premium has been paid off, the borrower will only need to pay their regular mortgage repayments. However, if the borrower refinances their loan or takes out a new loan, they may need to pay LMI again if they have less than 20% deposit.
Can You Avoid LMI?
If you want to avoid paying LMI, you’ll need to have at least a 20% deposit. This can be a significant amount of money, especially for first-time buyers. However, there are some other options that may help you avoid paying LMI, such as:
- Using a guarantor: If you have a family member who is willing to act as a guarantor for your loan, you may be able to avoid paying LMI. A guarantor is someone who agrees to take responsibility for the loan if you default on your repayments.
- Using equity: If you already own a property, you may be able to use the equity in that property as a deposit for your new home. This may allow you to avoid paying LMI.
- Choosing a low-deposit loan: Some lenders offer low-deposit loans that don’t require LMI. However, these loans may have higher interest rates or other fees.
Is LMI Tax Deductible?
While the LMI premium is paid by the borrower, it’s actually an insurance policy for the lender. As a result, it’s not tax deductible for the borrower. However, the interest paid on the loan is tax deductible, as long as the loan is used for income-producing purposes.
Conclusion
LMI is an insurance policy that protects the lender in case the borrower defaults on their mortgage repayments. It’s generally required by lenders when the borrower has less than 20% deposit. The premium is paid by the borrower and can be added to the total amount of the loan. LMI can be a significant cost, but it can help more people get into the property market. If you want to avoid paying LMI, you’ll need to have at least a 20% deposit or consider other options such as using a guarantor or using equity from an existing property.