Are you ready to take out a home loan? You might be curious about whether your home loan deposit is enough for the property you want.
There are a few lesser-known expenses involved when getting your mortgage up and running. A key one is Lenders Mortgage Insurance (LMI).
Below, we’ll break down what LMI means, how it’s calculated, where it works and where you could avoid it.
What is LMI? (Lenders mortgage insurance)?
When getting a home loan, you need to pay a deposit. Typically, this is 20% of the chosen property’s value. Sometimes, it can be difficult to meet this amount.
Lenders Mortgage Insurance (LMI) is afee lenders charge if the borrower is considered high risk. In many cases, this is when you borrow more than 80% of the property’s value, so paying less than the 20% deposit.
LMI is designed to protect the lender, not the borrower. If the borrower were to default (meaning they’re unable to meet their loan repayment obligations), LMI would prevent the lender from experiencing financial loss.
Why do you need to pay LMI?
LMI is often required when your home loan deposit is less than 20% of your property’s lender-assessed value.
From your deposit, the remaining value of the home that you would need to borrow would generate your Loan to Value Ratio (LVR).
When the LVR is greater than 80%, you’re generally seen as a higher risk to the lender.Therefore, charging LMI helps to protect them in case you’re not able to pay off your loan.
You might also like: What is Loan to Value Ratio?
How is LMI calculated?
There’s no universal amount for what is charged for LMI, as everyone has different circumstances. The amount mainly depends on the lender, the size of your loan and the size of your deposit.
Let’s break down the basics in the video below:
Your deposit
To the lender, your home loan deposit loan often indicates your ability to pay off your loan.
With a 5% deposit, you would be borrowing 95% of your property’s value. With a 15% deposit, it would change to 85%.
As both scenarios involve you paying less than a 20% deposit, LMI will likely be charged in both cases.
However, the 5% deposit would likely result in a higher fee for LMI than the 15% deposit. This is because you’re borrowing a larger portion of the property’s value.
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Other factors
Bear in mind, your deposit isn’t the only factor that contributes to LMI.
Other factors can include:
The overall size of your loan
Your property’s location (as stamp duty is payable on LMI)
Whether the property is for investment or personal use
Your employment stability – your lender may consider your employment history and status (full-time, part-time, casual)
Your lender’s LMI insurance provider
How is LMI paid?
There are two ways borrowers can pay LMI when taking out a home loan. The first is to pay the LMI amount charged upfront to the lender, at loan settlement.
The second (and more common) way is for that fee to be added to the loan amount. Essentially, LMI would then be paid off throughout the life of the loan.
It’s worth knowing that LMI is typically non-refundable and cannot be transferred to a new loan/lender in the case of refinancing.
This is because your original mortgage is terminated when you refinance. You’re essentially making a new loan arrangement, often with a different lender.
This means that you’d need to pay for a new LMI policy if you’re still borrowing more than 80% of the property’s value. If you have equity from your previous loan that’s 20% or more, you may not need to pay LMI.
Again, this all depends on the lender.
You might also be interested in: How does the first home owners grant work?
How to avoid paying LMI
The first tip to avoiding LMI might be obvious, but it’s to pay with a 20% home deposit. This could be actionable for some, as those with a deposit around 18-19% would only have wait and save a little longer.
However, it can be difficult to save more in some instances. Below are some more ways to avoid paying LMI if growing your deposit isn’t an option.
1. Explore other lenders
Shopping around for multiple lenders will boost your chances avoiding LMI. Not all lenders require borrowers to pay LMI when borrowing more than 80% of the property’s value.
By searching around, you’ll find some lenders will lend borrowers up to 85% of the cost of the property before charging them an LMI fee. In this case, these lenders would only require 15% deposit with no LMI, which could save you thousands.
There is a shortcut to this. An Aussie Broker can do the hard work for you and round up options that best fits your needs.
All you need to do is reach out to us for a free appointment.
2. See if you’re eligible for a professional home loan
Depending on your profession, LMI could be waived on your home loan. If you’re a doctor, dentist, accountant or engineer, lenders can provide special discounts and loan conditions due to your higher income.
The high income of these professions often signal a good employment tenure to the lender. In these cases, the borrower would present as a low risk.
It’s important to note that although this route is possible, the professions and discounts do vary by lender.
You might also be interested in: LMI waivers for professionals
3. Discover government schemes
Depending on your state or territory, the government have schemes in place for home buyers entering the property market.
If you’re unable to avoid paying LMI by saving a 20% deposit, you could check if you’re eligible for government assistance.
One of these is the First Home Guarantee (FHBG), a scheme run by the federal government. Its aim is to help first home buyers buy a property with a deposit as low as 5%, while avoiding LMI charges.
Other government schemes like the First Home Owner Grant could help boost your deposit over the 20% line, helping you avoid LMI.
You might also like: First home buyer guide: government grants and concessions
4. Get a guarantor
A guarantor home loan could be an option if you want to avoid paying LMI.
A guarantor is someone who uses their own equity to secure your home loan. This person is often an immediate family member or close relative. The equity would just need to be enough to cover that 20% deposit to avoid LMI.
It’s important to note that a guarantee is legally binding – if you can’t repay your home loan for any reason, the responsibility will fall onto the guarantor.
You can only remove a guarantor from your home loan once the value of the guarantee has been paid off.
Because the conditions of a guarantor home loan are strict, it’s best to speak with an Aussie Broker to make sure this option is right for you.
5. Use a financial gift
Were you gifted a lump sum at some stage? This financial gift could go towards a deposit to help avoid paying LMI.
When using a financial gift, it’s important that the money is declared as a gift – meaning it’s confirmed that you don’t have to pay it back.
You should also remember that financial gifts are typically viewed as non-genuine savings to lenders. This means that you’d likely have to show you have your own genuine savings that would also go towards your deposit.
Is it better to pay LMI or wait until I have a bigger deposit?
As we mentioned earlier, if you are close to a 20% deposit (such as 18-19%), then it might be better to wait. However, it is worth thinking this through and taking the property market into account.
There is no correct way to make this decision, but it could be smart to assess house prices in the area and consider that they may increase in a given period.
If property prices were to rise, the 20% deposit you would need to save would be higher by the time you’re ready to buy. Remember, the 20% is based on the current value of the property.
If you were to pay LMI before house prices increase, the total amount you spend upfront could be smaller, especially as LMI can be paid off throughout the life of your home loan.
Want to explore house prices now? Access your free property report here.
Do you need to pay LMI when refinancing or buying your next home?
Like with any home loan, LMI is charged when you are deemed a high-risk borrower to your lender.
There are a couple of instances where LMI would have to be paid when refinancing or getting a home loan for your new home.
When refinancing for the same home
Because you don’t need a home deposit to refinance for the same property, the attention is turned to your equity. Equity works in the same way a deposit did when you first bought your home.
To the lender, your equity demonstrates your ability to make home loan repayments. A higher equity would make you a lower risk borrower, and vice versa.
If you have at least 20% equity in your home, you should be able to refinance without paying LMI. If you have less than 20% equity, you might need to pay LMI – even if you’ve paid it before.
Remember, LMI is generally not transferrable. If you currently pay LMI on your existing home loan, this still needs to be paid. If you’re charged LMI on your new home loan, this will be a new fee.
You might also like: Refinancing your home loan to access equity
When buying your next home
A new property would usually require a new home loan. However, you can use your equity to go towards your new deposit.
The same rules apply with LMI: if your deposit is less than 20%, there will likely be an LMI charge. In this scenario, you could have gained some equity that could prevent this.
When borrowing, it’s important to know that you wouldn’t be able use your entire home’s equity to buy a property. In most cases, you can only borrow up to 80% of the value of your current home.
80% LVR is generally calculated by the lender, and 20% of that becomes your usable equity. Basically, this net amount would cover the deposit, or go towards it.
Here’s how you can calculate your usable equity:
Calculate 80% of the value of your home (for example: $500,000 x 80% = $400,000)
Subtract your current outstanding debt ($400,000 - $320,000 = $80,000)
Note: stamp duty and legal fees would need to be paid on top of your deposit.
Overall, it’s important to understand LMI to make an informed decision of your next home loan move. Whether you’re refinancing or buying your first home, you might need to pay LMI depending on your situation.
We’re always here to step you through your journey. You can talk things out with your local Aussie Broker to understand your home loan options by booking your free appointment today.
