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Buying your first home is an exciting time, but it can also be a little daunting. As a first home buyer, it can be difficult to save up a 20% deposit for your first home loan. You may be able to borrow from a lender with less than a 20% deposit, however, you might be stuck with paying Lenders Mortgage Insurance (LMI).
What is LMI? How does it work? And do you need it? We’ve got your sorted:
What is LMI?
LMI is an insurance policy paid for by you, the borrower, to protect your lender in the unfortunate circumstance that you default on your home loan. LMI is arranged by the lender and forms part of their approval process for your home loan application.
If you default on your loan, your lender may be forced to sell your home to repay the outstanding loan commitment you made. If the property’s sale value doesn’t cover the full amount outstanding on your loan, the lender may be able to recover this shortfall from the Insurance Provider.
Generally in Australia, if you are looking to borrow more than 80% of the property value, a lender will require LMI to protect the lender from losses.
Who does LMI protect?
LMI is often confusingly misunderstood as a protection for the borrower, when in fact LMI is taken out by the lender to protect their interests. However, the insurance premium is paid for by the borrower and is usually added to the total cost of the mortgage.
LMI reduces the lender’s risk in loaning money to you. Don’t confuse LMI with mortgage protection insurance, which does protect a borrower in case of default.
If you are considering buying your first home, speak to a mortgage broker about your options and whether LMI is right for you.
Get it right from the start with professional help.
When is LMI required?
When it comes to LMI, lenders may access different insurers and may have slightly different policies, which means there is no one-size-fits-all scenario where you will definitely be required to pay LMI.
Generally, LMI is required when you’re borrowing more than 80% of the property value.
When you apply for a home loan, your lender will assess the value of your property and make a determination.
If your Loan to Value Ratio (LVR) is more than 80%, your lender will typically require LMI to be paid, as your loan is considered to be riskier than a borrower who has built up more than a 20% deposit.
The Loan to Value Ratio, or LVR, is the percentage of the property value that you are borrowing. It is calculated by dividing the loan amount by the property value.
Let’s look at an example:
- You’re looking to purchase your first home, and your lender has assessed the property you wish to buy to be worth $800,000.
- You have saved a deposit of $80,000 (10% of the value of the property you’re seeking to purchase) on top of savings to cover the transaction costs of purchasing the property.
- Your LVR = 90%. That is, you will need to borrow 90% of the property’s value.
- It is also worth noting that when a lender calculates LVR, it is determined by the lesser of the purchase price and the independent valuation which may be carried out on the property. So it is wise to have a good idea of property values and not get carried away at auction.
Your LVR will play a role in whether your lender requires you to take out LMI.
How much does LMI cost?
The cost of LMI will vary depending on the lender and a number of factors.
Some discounts are available for first-home buyers, however, the cost generally increases as the LVR and loan amount increases.
LMI is also generally more costly for investment properties rather than owner-occupied properties and cost can vary according to your type of employment.
If you’re working with a mortgage broker, they will have access to premium calculators to help determine the cost of LMI and your lender will confirm the cost in any approval letters.
What happens if you default on a loan that is protected by LMI?
If the borrower defaults on a loan that is protected by LMI, the process is roughly as follows:
- The lender is still responsible for servicing notices and allowing the borrower the opportunity to rectify the situation.
- In some cases, it may be decided that it is best for the borrower to sell the property (often, this will occur because the borrower will get a better result from the sale than the mortgagee will).
- The mortgage insurer needs to be updated and made aware of the progression of the matter as they must provide their consent for certain actions, but they do not actually arrange the sale or interact with the borrower in any way.
The LMI process operates so that after the loan is wound up (either through borrower sale or mortgagee sale), if there is a shortfall where the property proceeds do not cover the outstanding loan amount (including accrued interest and fees), the Mortgage Insurance provider will pay the shortfall to the lender.
You think they would be the end of the matter, right? No. The LMI provider is able to go after the borrower’s personal assets to cover their losses. So, it is very important to work cooperatively with the lender in the event of default to ensure proceeds from the sale are maximised.
How can you avoid LMI?
Government initiatives: There are some state and federal government initiatives that allow you to avoid paying LMI in very specific circumstances.
Profession: Some professions and industries qualify for an LMI waiver, which is essentially a lender giving you an exemption from paying LMI because they consider you to be working in a secure, reliable and well paid industry. For example, medical professionals and doctors, lawyers, barristers, and professional athletes. Again, the criteria for such a waiver varies from lender to lender.
Security guarantee: There are a number of lenders in the market that can cater for an arrangement sometimes referred to as a family guarantee. This is generally where a family member may provide a limited guarantee secured by a property they own.
There are risks to the provider of the guarantee, so it is worth having a detailed discussion about this with your mortgage broker, as most lenders that provide this lending structure will also require the guarantor provider to seek independent legal advice. Anyone who agrees to be your guarantor is effectively taking on the risk that would otherwise be assumed by the LMI provider.
If you’re looking for some advice on how to maximise your first home purchase and would like to discuss the different LMI options available, reach out to us today for an obligation-free chat with our experienced YBR Home Loans mortgage brokers.