LMI was thrown into the spotlight recently, when the federal government launched the First Home Loan Deposit Scheme. This allows 10,000 eligible first-time homebuyers a year to get an LMI-free loan with a deposit of as little as 5%. Under the scheme, the government guarantees the shortfall needed to reach the 20% home loan deposit threshold normally required.
So what actually is LMI? How much does it cost? And when will you have to pay it?
What is LMI and how does it work?
LMI is an insurance policy that some home loan borrowers need to pay for. The purpose of LMI is to protect the lender from financial loss if the borrower can’t afford to meet their home loan repayments.
If the borrower defaults on their loan and the sale of the property doesn’t equal the unpaid value of the mortgage, lenders can claim on the LMI policy to make up the difference.
Many people believe that LMI is designed to protect the borrower in the case of loan default, but this is actually mortgage protection insurance, which is a different product. The true purpose of LMI is to protect and potentially benefit the lender. Additionally, by reducing the risk to the lender, LMI can allow banks and other financial institutions to lend larger amounts and approve more home loan applications.
If your lender requires you to take out LMI, it can typically be paid upfront or capitalised into (added to) your home loan. If the LMI amount is capitalised into your loan, you would generally be charged interest on it by your lender, along with the rest of your loan. LMI premiums are typically non-refundable which means if you switch your loan to another provider in the future, you generally won’t be able to transfer your LMI to another lender. Depending on the situation, you may have to pay for a new policy through the new lender.
When is LMI required?
Generally a lender will require you to pay for LMI if your home loan deposit is less than 20% of the total value of your property – so if your loan-to-value ratio (LVR) is more than 80%. However, as different lenders may have different rules, it could be worth checking what each individual lender’s policy is.
If you’re looking to avoid paying LMI but you don’t have enough of a deposit saved up, you may be better off not entering the housing market just yet, and waiting until you have saved up the 20% deposit that is generally required to avoid paying LMI. You could also consider the First Home Loan Deposit Scheme, if you are eligible.
If you’re currently considering a home loan, the comparison table below displays some of the variable rate home loans on our database with links to lenders’ websites that are available for first home buyers. This table is sorted by Star Rating (highest to lowest), followed by comparison rate (lowest-highest). Products shown are principal and interest home loans available for a loan amount of $350K in NSW with an LVR of 80% of the property value and that offer an offset account. Before committing to a particular home loan product, check upfront with your lender and read the applicable loan documentation to confirm whether the terms of the loan meet your needs and repayment capacity. Use Canstar’s home loan selector to view a wider range of home loan products.
*Comparison rate based on loan amount of $150,000 and a term of 25 years. Read the Comparison Rate Warning
What affects the cost of LMI?
There are a few factors that may affect the cost of LMI. These could include:
- The size of your home loan
- Your deposit amount
- Whether the property is for investment purposes or to live in
- Whether you are a full-time or casual employee
- The insurer used by the financial institution
1. The size of loan
The more money you are borrowing, the greater the potential loss to the financial institution in the event that you default. For borrowers, this typically means the bigger your loan, the higher the cost of the insurance.
2. Your deposit amount
The smaller the deposit you have, the higher the cost of LMI. For example, according to the Genworth LMI Premium Calculator, a hypothetical first home buyer (and owner occupier) with a 5% deposit for a property valued at $400,000 and a loan term of up to 30 years would pay approximately $11,897 in LMI. In comparison, if the same borrower had a 15% deposit, they’d pay about $3,770 in LMI costs.
3. Whether the property is for investment or to live in
Some financial institutions and insurers may differentiate between an investment and residential property purchase when it comes to LMI cost. Using the same amounts as the hypothetical examples above, an investment borrower who is not a first home buyer with a 5% deposit would pay around $15,190 for LMI, and the same investment borrower with a 15% deposit would pay around $4,815, according to the Genworth LMI Premium Calculator. Based on these sample calculations, an investor could pay around 20% more for LMI than an owner occupier.
4. Full-time or casual?
Your employment status can also affect the perceived risk of lending to you, so this is another factor that might affect your LMI premium.
5. The insurer used by the financial institution
There are several providers of LMI and, just like any other insurance product, premiums can differ between institutions.
What does LMI cost?
How much LMI actually costs will depend on a range of factors that collectively affect your lender’s risk assessment of you as a borrower.
To give you a rough idea, we’ve used the LMI calculator available through one of Australia’s largest LMI providers, Genworth, to give you some hypothetical ‘ballpark’ cost calculations. This is based on the upfront premiums payable (excluding stamp duty) for a first home borrower. If you decide to capitalise your LMI into your home loan, you’ll also have to factor in the additional interest you would be charged on the insurance amount over the life of the loan.
|How much is Lender’s Mortgage Insurance?|
|Cost of property||5% deposit||10% deposit||15% deposit|
Source: Quotes taken from Genworth LMI premium calculator, correct as at 15 June 2020 . Premiums listed are for first home buyers (owner occupiers) borrowing with a loan term of up to 30 years and excluding stamp duty.
As you can see from the above, LMI can come at a hefty price, so it might be worth looking for some strategies to avoid the cost, if at all possible.
How to avoid paying or reduce the cost of LMI
In some circumstances, you may be able to avoid or reduce the cost of LMI. Here are a few ways you might be able to do so:
- Grow your deposit to 20% or more
- Get a family member to go guarantor
- Apply for the First Home Loan Deposit Scheme
- Compare LMI quotes from a number of lenders
1. Grow your deposit
To avoid paying LMI, you typically need a deposit of 20% or more of the lender’s valuation of the property. It might be useful to weigh up the pros and cons of giving yourself more time to save, compared to getting into the property market earlier.
If you need a savings kick-start, Canstar has compiled 10 strategies for saving for a home deposit you might like to consider. For instance, a high-interest savings account is one method that’s commonly used to save and grow money for that all-important deposit. Some institutions also offer savings accounts specifically designed for those saving up for a home deposit.
Alternatively, you might be able to ask your parents to chip in. A cash gift from your parents or another relative could be enough to get you over the line and avoid LMI. However, this does come with financial risk. Some financial institutions are unwilling to accept cash from a third party as genuine deposit savings, while others will allow you to avoid LMI with this strategy.
2. Have a family member go guarantor
A guarantor is someone who guarantees part or all of your loan so that in the event that you can’t pay, the responsibility would fall to them. This eliminates much of the risk for a lender, but can place a great deal of risk on the person or people acting as the guarantor.
This decision should not be taken lightly. After all, the person going guarantor is potentially risking their own savings and assets, including their home in some cases. You can read more about going guarantor on a home loan here. Since it is a major decision to make, it may be a good idea to seek professional advice before making a decision.
3. First Home Loan Deposit Scheme
If you’re an eligible first home buyer, another option is to apply for the government’s First Home Loan Deposit Scheme. Under the scheme, eligible homebuyers can apply for a loan with a deposit as small as 5% and wouldn’t need to pay for LMI if the lender approves the loan. The government essentially guarantees the additional amount needed to reach a 20% deposit.
First home buyers with an annual income of up to $125,000 (or $200,000 for a couple) are eligible. Keep in mind that this scheme is only available to 10,000 first home buyers each year, which up until now has represented a relatively small fraction of the market. Consider checking whether there is availability in the current year, or whether you would need to wait to apply the following year.
4. Compare LMI quotes from a number of lenders
As already mentioned, the cost of LMI can differ between financial institutions. The two main providers of LMI in Australia are Genworth and QBE. Generally lenders have contracts with one or both of these providers and may have negotiated a specific set of arrangements with them for their customers.
Some lenders will also self-insure loans for some borrowers. Before you begin the home loan application process, feel free to ask a few financial institutions for an estimated cost of LMI. It could potentially differ significantly between providers.
In addition to the steps above, consider too that lenders and their insurers view some occupations as being at less of a risk of redundancy or job loss, and may waive the cost of LMI if they view an applicant as being particularly secure. For example, according to Mortgage Choice, LMI may be waived for LVRs up to 90% for certain professions including medical and legal professionals who have reached a requisite seniority level. However, Mortgage Choice says this will be assessed on an individual basis and you may need to also be a member of specific professional associations. It could still be worth asking your lender about it.
What is a Home Loan Comparison Rate?