Lenders Mortgage Insurance

Buying a home is a very emotional decision and properties and suburbs are coveted and dismissed on the basis of how the neighbours look, how the streets feel and whether the home itself is somewhere you think you could be comfortable providing for your family. At the same time you need to remain cool and clear headed and make sure your interests are protected because there is a lot of money involved, and you are promising a lot of years of your life to repay that money.

Therefore, it is important that you understand the insurances and protections applied to your mortgage and home loan application, especially when some of the insurance you are paying goes towards protecting your lender, not you.

Lenders Mortgage Insurance is payable on most Australian home loans and while most borrowers are hit with the cost, few take the time to find out why they are paying, what they are paying for and how they can avoid this cost.

A High LVR Means a High LMI Premium

As the LMI is meant to protect the lender, it is applied to home loans that incur a higher level of risk from their viewpoint. While, in general, this level of risk is directly related to the level of the LVR, it can also be determined by the strength of the applicant. However, any loan with an LVR in excess of 80%, will incur an LMI fee, no matter how strong the financial position of the applicant is. Since LMI premiums are generally calculated as a percentage of the amount being borrowed, an LMI calculator can be used to estimate the approximate cost of this insurance policy.

It is advisable that you do your research because LMI premiums can vary significantly from one lender to another and also according to the level of the LVR. For example, an LVR of 90%, even if it’s only by one dollar, will incur a much higher LMI premium than an LVR of 89%. Thus, you should make sure to work out the figures with an LMI calculator as you can save thousands of dollars.

Do Home Loans Have to Be Approved by the Mortgage Insurer?

You might be surprised, but applications for risky home loans also have to be approved by the mortgage insurers. Essentially, they are taking over the risk for the lender, meaning that they want to hedge said risk as much as they can. Thus, you will find that mortgage insurers are just as conservative, if not more so, than lenders, requiring the borrower to have a credit history with no blemishes, a savings record and stable employment.

The lender will take care of submitting the documentation to the mortgage insurer, but cannot guarantee your application will be approved if you do not meet the criteria.

What If I Don’t Have the Cash to Pay the LMI Premium?

You may choose to put all your available cash towards the deposit to ensure that your LMI premium doesn’t go through the roof. In some cases, you might be able to save thousands of dollars, but you can work out the exact figures with an LMI calculator to determine whether it’s worth it or not. However, the result is that you are short the money needed to cover the LMI premium charged on risky home loans.

The good news is that some lenders allow LMI capitalisation, which means that the premium is worked into the loan. So, normally, if you borrow $150,000 and your premium is around $1,400, then you will only receive $148,600, as the balance will go towards paying the LMI premium. With LMI capitalisation, though, you will get $151,400 allowing you to use the full $150,000 you applied for.

Many borrowers don’t realise how much money they can save by taking the time to do their due diligence properly. LMI premiums vary significantly and a little preparation, which can involve a few calculations using an LMI calculator as well as seeking professional counsel form a mortgage broker, can save people thousands of dollars on their home loans.

What is Lenders Mortgage Insurance?

Lenders Mortgage Insurance is the insurance which protects your lender in case you default on your home loan repayments. You will only be required to pay LMI if your loan is high risk – in other words there is a high risk that you will default because you have a bad credit rating, you are a contract worker or you are borrowing a large percentage of the value of the property.

Typically you will pay Lenders Mortgage Insurance on your home loan if you are borrowing more than 80% of the property value on a standard loan, or more than 60% of the property value on a low doc loan.

You pay LMI in a once off payment when you apply for your loan and the level of risk assessed by the LMI underwriter does not affect your interest rate. The lender also organises all of the paperwork for LMI during the approvals process so you don’t have to do anything but pay it.

Why do you pay Lenders Mortgage Insurance?

When you are applying for a loan, you may see the deposit as another expensive inconvenience in the way of your loan approval. However, you pay a deposit on your home loan to bring down the amount you are borrowing, and widen the gap between the loan amount, and the value of the property you are borrowing against.

This is because, before 1965 lenders would only approve loans for up to 80% of the property value to reduce their risk, and increase the gap between what you owe, and the value of your security. However, this made it very hard for some buyers to secure a home loan, especially first home buyers.

As a result Lenders Mortgage Insurance was introduced to remove the risk from the lender if you are unable to repay your loan. The insurer takes on the risk of loss if you default and your property must be sold and you can get into your home with just a 5% or 10% deposit rather than needing to save up 20%.

It is important to remember that you are paying LMI to protect the lender, not yourself. The LMI insurance policy does not cover any damage to the property, and is different to loan protection insurance which protects you if you can’t make your repayments because of illness, injury or unemployment.

How is Lenders Mortgage Insurance Paid?

You pay Lenders Mortgage Insurance once, at the time your loan is approved. For example, if you are borrowing $100,000 and the LMI premium is $1,000 your lender will advance you $99,000 and the LMI goes to the insurer.

Lenders Mortgage Insurance may also be paid by the process of LMI capitalisation where the premium is added to your loan amount. For example, if you are borrowing $270,000 and your LMI premium is $2,500 the premium is not deducted from your loan amount, but is instead added to the loan amount and so you are actually borrowing $272,500 and you pay off your LMI as part of your loan.

How is Lenders Mortgage Insurance Calculated?

The insurers who underwrite Lenders Mortgage Insurance use an LMI Rate Chart or a Premium Table to calculate the amount of LMI payable based on the level of risk in your loan. A percentage of the loan amount is charged as LMI, based on the size of your loan in relation to the value of the property you are borrowing for – this is known as the loan to value ratio.

For example, if you are borrowing $255,000 to buy a property valued at $300,000 you are borrowing 85% of the property value, so your loan to value ratio is 85%. Even though you are borrowing more than 80% of the value of the property, the loan is small and the LVR is low, so you will probably pay the minimum LMI premium.

However, if you borrowed $950,000 on a property valued at $1 million then your LVR is 95% and the LMI premium is likely to be very high. At the same time, different Lenders Mortgage Insurance providers offer different premium rates and there can be differences of thousands of dollars between the LMI on the same loan to value ratio between insurers.

Who calculates Lenders Mortgage Insurance?

While there are a number of LMI insurers in Australia, the choice of company is not up to you, but determined by your lender. Home loan lenders have commercial agreements with one to two insurers who will then approve your loan and risk level. While you can’t choose your LMI insurer, you can choose your lender and by asking your mortgage broker which insurer each lender uses, you can secure the lowest premium.

At the same time, you will want to choose an insurer who will approve your loan because the approvals process of your ability to service the loan is part of your risk assessment. When a home loan has no or little deposit mortgage insurers are less likely to approve the loan, unless you can show you have a stable employment history, a good credit history and evidence of savings.

Alternatively, some lenders will have forged a very close relationship with their insurance provider, and this can give the lender the ability to approve loans on behalf of their insurer. This is called Open Policy, or Delegated Underwriting Authority and if you use this type of lender, you can have your loan approved, where it may have been declined by the LMI insurer.

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