Lenders Mortgage Insurance (LMI) explained

• A complete guide to LMI written in plain and simple English.
• Find out what LMI is, what it is for, and who it protects.
• Learn how much it typically costs and how you can avoid it.

In Sydney, potential homebuyers are facing anaverage home loan of $621,500. The situation isn’t much better in cheaper places like Tasmania, where amounts are nearly $250,00 below Sydney’s average.

With these amounts, saving up for an initial deposit doesn’t come easy. If you want to buy a home without shelling out hundreds of thousands for a deposit, you’ll will probably have to pay for Lenders Mortgage Insurance (LMI).

If you’re dipping your feet in the property market for your first home, you need to know how Lenders Mortgage Insurance can affect your home loan. In this guide, we’ll talk about what LMI is, what it’s for, and how you can avoid this extra expense.

Defining LMI

Lenders Mortgage Insurance (LMI) is a type of insurance that protects the home loan lender against potential losses in case the borrower defaults on their loan. Lenders may require you to purchase LMI if you do not meet the minimum requirements for a deposit.

In most cases, LMI is requested as an upfront, lump-sum cost. However, you can request for its cost to be bundled in with your home loan instead. If you take this route, you will have to pay interest on your LMI on top of the rest of your loan amount.

LMI is non-refundable, even if you decide to transfer your loan to another provider in the future. LMI isn’t to be confused with Mortgage Protection Insurance (MPI), which protects borrowers in case they can no longer pay off their loan due to illness, unemployment, or death.

When is LMI necessary?

A lender might request that you pay LMI if you’re unable to provide a deposit of at least 20% of the property’s lender-assessed value. A deposit of less than 20% of the total amount means that your loan-to-value ratio (LVR) is over 80%, which is usually considered high-risk for lenders.

Though different lenders will impose different standards regarding LMI, the regulations surrounding it are generally the same. When in doubt, talk to your lender – they should tell you everything you need to know about your LMI, especially how much it will cost.

How much does LMI cost?

The cost of your LMI will vary according to several factors, which include the following.

Loan size

As with any type of loan product, the more you borrow, the more risk your lender takes on. This is directly reflected in the cost of the LMI. For example, a prospective homeowner with a property value of $1,000,000 and a loan-to-value ratio (LVR) of 85% can expect to pay roughly $10,000 more in LMI alone compared to one with a property value of $200,000 and a similar LVR.

Deposit amount

Deposit amount is another major risk factor for lenders. The smaller the down payment, the higher the cost of LMI. Let’s say you’re purchasing a 30-year home loan for a home worth $400,000. A 5% deposit ($20,000) would result in an LMI of $12,000. At a 15% deposit ($60,000), the LMI will be significantly lower at approximately $4,000.

Type of loan

The type of loan product you apply for can also directly impact your LMI. A low-documentation loan, which accepts alternatives to traditional proof of income, will charge LMI if a borrower takes out more than 60% of the property’s value. For conventional home loans, LMI is usually only required if you borrow more than 80%.

Purchasing purposes

Some homebuyers purchase property as an investment rather than to live in. If you’re purchasing investment property, lenders will assume that you are not a first-time homebuyer. They may charge you up to 20% more for LMI than they would an owner-occupier.

Another way to get approval on a low-deposit investment property loan is to get a parent to go guarantor, meaning you won’t have to pay LMI.

Employment status

Lenders tend to be more trusting of borrowers who have a full-time job because employed individuals are more able to repay a loan. Self-employed people and casual workers are considered riskier and are likely to be charged higher LMI.

How to calculate LMI

Ultimately, how much your LMI costs will depend on your lender’s independent risk assessment of you. However, you can still get a ballpark cost through an online LMI calculator.

You can also calculate your LMI premium on your own. Start by working out your property value and the percentage you’re borrowing against it – that’s your LVR.

Say you’re borrowing at an 85% LVR on a property worth $300,000. Based on an online premium calculator, your LMI rate against an 85% LVR would be 0.727%.

Multiply your LMI rate by your loan amount to get your premium:

$300,000 loan x 0.727% rate = $2,181 LMI premium

Keep in mind that the overall cost of your LMI will be higher if you decide to funnel your LMI into the home loan itself, mostly because you have to pay interest on it.

How LMI affects your home loan

Whether you pay it upfront or absorb it into your home loan, LMI increases the overall cost of your home loan. Consider consulting a home loan broker to get a more accurate picture of your monthly costs with LMI factored in – this will allow you to reassess your budget and determine whether or not it’s still the best option for you.

Some home loan insurance companies may also require that you undergo an additional approval process for LMI. Larger entities may impose stricter criteria than independent brokers, so the process may become time-consuming and delay your plans.

LMI & taxes

If you’re buying a home, both stamp duty and GST are included in the quoted price of your LMI. If you’re buying property for investment purposes, a portion of your stamp duty and GST can be claimed as tax-deductible.

How to avoid LMI

If you don’t want to pay thousands of dollars in LMI, there are a few ways to avoid this expense:

Save for a larger deposit

A 20% deposit will save you from the additional costs of LMI. However, considering the high costs of property today, this could take years. Consider quick-growing methods, such as a higher interest savings account or accounts specifically designed for home deposit savings.

Alternatively, you can ask a family member if they’re willing to chip in for your deposit. However, keep in mind that some lenders will be unwilling to accept a deposit from a third party. You can formally facilitate this through a gifted deposit, under which a family member can pay for a portion of, or the entirety of, your deposit.

A gifted deposit is not a loan, as there is no legal obligation for a borrower to repay the amount. To qualify for a gifted deposit, you need to present a letter to your lender that states that the giver has no stake in the property, no commercial interest, and no expectation of repayment.

Get a guarantor

A guarantor accepts legal responsibility for your monthly repayments if you can’t pay, reducing the risk for lenders. Through a guarantor home loan, your sponsor – typically a parent or close family member – puts forward a portion of their own home equity as security for your home loan. By doing so, they can reduce your LVR and eliminate the need for LMI.

While you minimise the risk for a lender, this type of home loan can put your guarantor in a financially vulnerable position if you both default on the loan. In the worst case, your guarantor could lose their property. Always seek professional advice before pursuing a guarantor home loan.

Apply for the First Home Loan Deposit Scheme

If you’re a first-time homebuyer, you may be eligible for the First Home Loan Deposit Scheme (FHLDS). Through the FHLDS, you can apply for a loan with a deposit as low as 5% without the need for LMI. To qualify for the FHLDS, you must:

• Be an Australian citizen
• Be at least 18 years of age
• Earn less than $125,000 if single, or $200,000 combined if in a civil partnership (e.g. not including siblings, parents and children, or friends)

Applicants also can’t have previously owned land or held a stake in a residential property at any time. Price caps on FHLDS homes vary based on region, and they only accept 10,000 applicants a year, although additional places were made available on the 2020-21 federal budget, specifically for newly-built homes.

Consider a different lender

LMI costs can differ between lenders. Some smaller-scale lenders will self-insure, so make it a point to enquire with more than one lender to get the best possible rates.

Disclose your occupation

Rates are usually more forgiving for those who work in high-paying industries. For example, those who work in the healthcare industry or law can borrow up to 90% of a property’s value – 10% more than people in other careers – as long as they can provide proof of income.

Refinancing your home loan

If you’re on a variable rate home loan, you may decide to refinance your loan should rates become too high. Unfortunately, LMI is lender-specific and cannot be carried onto a new loan. Unless your refinancing is less than 80% of the property value, you’re likely to have to pay LMI again.

Alternatives to LMI

If you can’t avoid paying LMI, you could consider a risk fee as an alternative. This fee allows lenders to offer more affordable entry costs to those with a high LVR. A risk fee is also sometimes known as a Reduced Equity Fee (REF) or Low Deposit Premium (LDP).

The maximum allowable LVR on a risk fee paid upfront by the borrower is 95%. If you absorb the risk fee into your home loan, you can borrow up to 97%.

Risk fees are not processed by an external insurer. Because of this, they don’t charge government taxes such as GST and stamp duty.

How can you apply for a risk fee?

Risk fees are available with select banks and non-conforming lenders. Non-bank lenders may be more accommodating of higher-risk clients with bad credit.

With bank lenders, you typically have to meet the following requirements:

• Proof of full-time employment for at least two years
• A good credit score of at least 700

Some banks may also ask for proof of genuine savings.

In contrast, non-bank or non-conforming lenders may have a more lenient process. Requirements include an affordability test and proof of income.

Lenders Mortgage Insurance FAQ

Does LMI protect the borrower?

No. LMI protects your lender if you default on your loan.

How does LMI benefit borrowers?

Though it may cost a homebuyer more in the long run, LMI helps individuals enter the property ladder quickly – even with a deposit as low as 5%. It can also enable buyers to purchase more expensive property.

Can you get a refund on LMI?

LMI is neither refundable nor transferable if you choose to refinance your loan. However, you could get a partial refund if you repay the loan within two years.

If you repay your home loan within 12 months of the date of settlement, you may get a 40% refund on your LMI. If you repay within 24 months, the refund may be 20%.

What happens if you default on your loan?

When borrowers default on their loans, the lender could repossess the property and sell it to cover the unpaid balance. If the money from the sale isn’t enough to cover all the losses, a lender can make an LMI claim with the insurer.

Borrowers are still responsible for the outstanding debt. A new financial agreement will decide the repayment terms for the borrower/guarantor.

How long do you have to pay for LMI?

Most lenders will request that an LMI be paid upfront in a lump sum. However, you can choose to funnel the amount into your loan. You’ll pay a little extra on top of your home loan every month to cover the LMI. It’s important to note that doing this will increase the cost of your LMI due to interest.

What if you can’t afford LMI?

If you can’t afford a 20% deposit or an up-front LMI, you might be able to get a gifted deposit from a family member. Alternatively, you could get a guarantor on your loan or absorb your LMI into your home loan.

What is the difference between LMI and MPI?

Lenders Mortgage Insurance and Mortgage Protection Insurance protect two different parties in two different scenarios but for the same loan. LMI protects a lender in the case of a default, while MPI protects a borrower in the case of illness or death.

Can you borrow more than 80% of the purchase price?

Yes, you can borrow beyond 80% of a property’s value in the following cases:

• You qualify for the First Home Loan Deposit Scheme – this boosts your borrowing capacity to 95%.
• You receive a gifted deposit, boosting your borrowing capacity to 95%.
• You take out a personal loan as a deposit and are considered a low-risk borrower. This boosts your borrowing capacity to 95%.
• You offer equity from another property as security, allowing you to borrow up to 100%.
• You get a guarantor on your loan from a family member who owns property inside Australia. You can potentially borrow up to 105%.

Are there exemptions to LMI?

In some cases, a lender may waive LMI if you meet specific criteria, like:

• An LVR that is only slightly over 80%
• An LVR of up to 90%, specific to qualifying professions
• An internal LMI substitute – such as a risk fee – with your bank or lender

You need to provide proof to qualify for a discount or exception.

What professions are exempt from paying LMI?

People who are employed in the following industries may be eligible for an exemption:

• Healthcare (e.g. doctors, veterinarians, dentists, optometrists)
• Finance (e.g. accountants, auditors, CFOs)
• Law (e.g. solicitors, barristers)

You may need to submit proof that you are a member of a specific association within your sector.

In conclusion

As home loan amounts continue to skyrocket across Australia, many first-time homebuyers are struggling to come up with the minimum deposit amounts required to purchase a property. If you don’t have the time to save up for a deposit, you can enter the property market quickly by paying Lenders Mortgage Insurance.

LMI could be worth the extra cost if you’re confident that your property value will increase, at least enough to account for the expense. It could also be worth it if you intend to live in the home over the long term.

However, keep in mind that LMI protects the lender – not you. You may not want to pay thousands in insurance that does nothing to protect you. It’s cheaper to avoid LMI by asking for financial assistance from family members, applying for the First Time Home Loan Deposit Scheme, shopping for a different lender, or paying a risk fee.

When deciding between LMI or putting off your property purchase until you have a larger deposit, you need to consider your unique circumstances.