Should you keep saving for a home or buy now and pay LMI?

Saving a 20% deposit may mean you avoid paying lenders mortgage insurance but is it always the best move? Here’s what to consider.

Spending years saving a 20% deposit to avoid Lenders Mortgage Insurance (LMI) can be a case of false economy. There’s a strong argument that first home buyers could be better off going in with a smaller deposit, paying the LMI premium and enjoying the benefits of home ownership.

“It’s much harder to save than to pay a mortgage. People are better off paying the LMI premium and getting in and owning their home – particularly when you have a mortgage rate under 2.5%,” said mortgage broker Louise Lucas of The Property Education Company.

The two major providers of LMI in Australia – Genworth and QBE – promote LMI as one of the most popular ways to achieve home ownership sooner for borrowers who don’t have a large deposit.

“Achieving the dream of home ownership can be one of the most exciting times in your life. It can also be one of the most difficult to accomplish due to the length of time it can take to save the traditional 20% home deposit,” QBE says. “LMI provides lenders with the security to accept a smaller deposit from you. By reducing the deposit required, you may be able to purchase a home much earlier, or buy a better located or better-quality property, than your deposit would otherwise have allowed.”

Sounds idyllic but, of course, LMI can be expensive. Those with a small deposit can pay more than $20,000 in LMI premiums, even on a relatively modest $600,000 home.

How to avoid paying LMI

You can avoid or reduce your LMI costs by saving a larger deposit or using a parental guarantor to cover part of your deposit. Eligible first home buyers can use the First Home Loan Deposit Scheme to avoid LMI completely.

Early in December, it was announced that another 4,600 places were being made available under the federal government underwriting scheme, which allows first home buyers to borrow with a deposit as low as 5% and single-parent families as low as 2%, without having to pay LMI premiums.

Some can avoid LMI if they work in highly-regarded professions. Lenders often waive LMI for accountants, lawyers, professional athletes, entertainment professionals, and mining specialists if their LVRs don’t exceed 90%. They’re considered low-risk because they tend to have high incomes.

Another way to escape the LMI fee is with the help of mum and dad. “Quite a few borrowers have a parental guarantee. If the parents have an unencumbered property, they can offer that as security instead of paying LMI to cover the required deposit,” Ms Lucas explained. “The preference by most lenders is to use an unencumbered property that’s not their primary residence – such as a holiday home or an investment property. But every lender has their own rules around this.”

Some lenders will waive LMI for first home buyers if they have a 15% deposit. Lenders such as UBank, St George, Bank of Melbourne, Bank SA, Bank of Queensland and 86400 don’t charge LMI fees (or charge a nominal $1) if you can stump up 15%. RAMS offers discounts on LMI for first home buyers who have deposits of only 5% or 10%, while Bank Vic charges no LMI if you have a 10% deposit. (See the table below)

LMI special offers

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Source: www.canstar.com.au – 14/12/2021. Offer details based on advertised offers. Table may not be comprehensive. Other terms and conditions may apply, check with the provider for more information.

Scenarios for those who can’t avoid LMI

For those who do have to pay LMI, premiums are payable in two ways – an upfront fee or by capitalisation. Capitalising your LMI premium essentially means adding it to the total loan amount and paying it off in regular instalments with your home loan.

Some borrowers have a 20% deposit but most do not and therefore face the LMI hurdle. But going ahead and buying with a deposit of only 10% or 12% can make more sense than waiting and saving more, said Ms Lucas.

According to Ms Lucas, a nice compromise is having a deposit of 12%, in which case the LMI is not overly expensive.

“To get the maximum benefit from this scenario, get the LVR down to 88%. You get a better bang for your buck at that level, because if the LVR is 90% the LMI fee jumps quite high,” she explained. “So, if you have a 10% deposit, beg, steal or borrow from family for the extra few thousand you need to get to 12% because you could end up paying $4,000 or $5,000 less in LMI.”

Should you buy now and pay LMI?

Here’s a possible scenario, based on a first home buyer seeking a $600,000 home. According to the Genworth calculator, a first home buyer with a 10% deposit, would be charged around $13,000 for LMI. With a slightly bigger deposit of around 12%, the LMI fee would be $8,500. With a 15% deposit, the LMI fee would be $6,400.

If the deposit for that $600,000 loan was only 5%, and the first home buyer couldn’t access the federal scheme, the LMI premium would be around $24,000.

So, imagine a couple in that situation. They want to buy a $600,000 home and they have saved $30,000 as a deposit (5%). They need to save another $90,000, to avoid the $24,000 LMI premium.

But property values have grown, on average, 22% in the past 12 months. Assuming, for this exercise, that price growth moderates in 2022 to, say 10%, a year from now that target home would cost $660,000.

That means the couple would now need to save not $90,000 more, but $102,000 more (on top of the $30,000 they currently have), to accumulate a 20% deposit. And, unless they’re living with parents, they would have to do it while paying rent.

But if they decide to buy now, they have to pay $24,000 in LMI but they can add that to their loan – and, with property values growing at 10%, the market uplift will more than compensate in six months.

The couple has converted their rental payments into mortgage payments, they own their home and they have avoided the prospect of having to save more and more to get to a 20% deposit because property values keep rising.

A couple with a 12% deposit ($72,000), can pay an LMI fee of $8,500 to avoid having to save another $48,000 and they can achieve home ownership much sooner while enjoying the capital growth uplift that’s currently in the market.

Ms Lucas uses a recent case study to illustrate an ideal scenario to young buyers. First home buyers purchased a property at Pakenham, Victoria, for $495,000 in June 2020. They used the federal scheme so they paid no LMI, they received a state government grant and they paid no stamp duty because the price was below the threshold of $600,000. In September 2021, the property was valued at $670,000 – a capital gain of $175,000 in 15 months.

Such a scenario illustrates the possibilities, even if you do have to pay LMI fees. “Even if the rate of price growth eases, they’re still paying off their home rather than paying rent and trying to save a deposit at the same time,” Ms Lucas said.

Of course, you also need to consider the risk that property prices fall. If that happens, the value of the property would be lower and you may have been able to avoid the need for LMI.

Cover image source: MEE KO DONG/Shutterstock.com

About Terry Ryder

Terry is the founder and Managing Director of hotspotting.com.au, which he created in 2006 to help investors find the best places to buy. Terry has been a specialist researcher and writer on Australian residential property in a career spanning four decades. During that time he has published four books.

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