Lenders Mortgage Insurance (LMI) is a fee banks and other finance lenders charge borrowers when they are deemed high risk. Usually, this is when their deposit is less than 20% of their property’s purchase price.
Made by the borrower at the time of the property settlement, the one-off payment protects the lender in the event that the borrower cannot make the repayments on their home loan.
When is it due?
Generally, the borrower pays the LMI payment in a lump sum at settlement. However, many lenders will offer to finance LMI into your home loan, so that it is added to your monthly mortgage payments. This means you won’t need to have the funds upfront, but it also means you’ll need to pay more interest on your loan, which will result in higher monthly repayments.
Lenders require this type of insurance when a borrower has a small deposit – generally when it’s less than 20% of the purchase price – because the risk of the borrower defaulting on their loan is much higher than it would be if they had a larger deposit, as their monthly repayments are much higher.
Taking out the insurance allows lenders to make an insurance claim if the borrower defaults on the loan and the property sells for an amount that’s less than the value of the mortgage. The difference between the sale price and the value of the mortgage is the ‘shortfall’, and this is what the lender will seek to recover from the LMI provider should the borrower default on their loan.
Keep in mind, that even if the lender successfully recovers the shortfall, the LMI provider may still seek to recover the shortfall from the borrower. As the borrower you may want to take out Mortgage Protection Insurance to protect you in the event of loss of income, injury, or death – this is a different product.
How much does it cost?
Each LMI provider calculates the cost of LMI slightly differently. Below is a list of the main factors that impact on the cost of LMI.
- The size of the loan: the more money you borrow, the larger the LMI will be. That’s because the more money the financial institution lends you, the greater loss they face in the event that you default.
- The size of your deposit: If your deposit drops below 20% of the property’s purchase price, you’ll need to pay LMI. And the lower it drops, the more LMI you’ll have to pay. This is because you’re more likely to default on your loan when you have a very high loan-to-value ratio (LVR).
- Whether you’re buying for investment: Some LMI providers will charge different rates if you are purchasing a property to rent out, rather than to live in.
- Your employment status: LMI providers tend to charge higher rates for people who aren’t in a regular, full-time job, as alternative forms of employment are generally considered more vulnerable.
In summary, most borrowers are subject to LMI; however, if you have a larger than 20% deposit or a guarantor on the loan to wear the risk in event of default, for example a family member such as a parent(s) you can often avoid this additional cost.