Lenders Mortgage Insurance Explained
Most homebuyers try to avoid having to pay Lenders Mortgage Insurance by saving the full 20% deposit. But is LMI really that bad?
20% is the magic number for a home loan deposit. It will get you out of having to pay Lenders Mortgage Insurance (LMI). But is LMI really that bad?
LMI was introduced to encourage banks to lend more than 80% of a property’s value, so homebuyers didn’t need to save the full 20% deposit and could purchase sooner. It’s an insurance that protects the banks, not the borrower who pays the premium.
First home buyers who successfully apply for the First Home Loan Deposit Scheme (FHLDS) can pay as little as 5% deposit and the government will guarantee the 15% balance.
But if you’re not a first home buyer and your deposit is less than 20% of the loan amount, LMI will apply. It’s a one-off premium that you will have to pay at settlement. But consider this: if your home rises in value over the time it would have taken you to save the full 20% deposit, by an amount at least equal to the LMI premium, then financially you haven’t lost anything.
Let’s say you’re looking to buy a home for $750,000. To avoid LMI you would need to save a 20% deposit of $150,000. Even if you could save $20,000 a year, it would take 7.5 years to squirrel away that amount.
But what if you only saved 10% for the deposit and paid the LMI? Well, for a start you would only need to save $75,000 – which at $20,000 a year would take less than 4 years.
That’s a big difference, and a lot can happen in that time. Most notably, during those extra years, house prices could rise. That means you would either have to settle for less house than you expected to get for your $750,000 budget or raise your budget and further extend the time it would take to save the deposit.
Of course, the reason people try to avoid paying LMI is because it can be expensive. The actual cost depends on the amount you want to borrow and how much deposit you pay (called the Loan to Value Ratio, or LVR).
The LMI premium for a 5% deposit could be almost four times higher than for a 15% deposit. This handy LMI calculator from Genworth will give you an indication of the cost in real terms.
Another problem arises if your home depreciates in value. Financially you will be going backwards. And the worse your LVR, the higher the interest rate on your home loan is likely to be.
So while LMI allows for a deposit as low as 5%, the best advice is to aim for the highest deposit you can manage – at least 10% – and avoid the worst of the pitfalls.
Talk to your financial adviser to determine how LMI might affect you. Then get in touch and we’ll help you find your dream home at The Junction!