Alan Hartstein
Athena Cocoves
Lenders mortgage insurance, or LMI, is one of several fees you may encounter on your journey to home ownership, but unlike some others, it’s one you can avoid in certain circumstances.
LMI is only required when the deposit is less than 20% of the price. Although the owner pays the cost of LMI, its coverage protects the lender.
How does LMI work?
LMI is insurance that your mortgage lender takes out to protect themselves if you default on loan repayments and the property is sold for less than the outstanding amount on the mortgage.
Let’s say, for example, you bought a property for $400,000. But, after three years, you cannot pay the mortgage, and the lender is forced to sell. If the property’s value has fallen to $300,000 with $370,000 still owed on the mortgage, LMI will make up the $70,000 difference. As such, LMI protects the lender, so as the borrower, you can never make a claim on it.
LMI is also distinct from other types of insurance, such as home and contents, title insurance or disability/work-related insurance, which may allow you to continue paying your mortgage even if you lose your job.
» MORE: What is mortgage protection insurance?
How much is LMI?
LMI is as a one-off, upfront cost paid when a borrower’s deposit is less than 20% of the home’s price. The borrower pays the fee to the lender at settlement time, who then pays the insurer. The policy is good for the life of the mortgage, regardless of its length.
Any fees the insurer charges the bank will then be passed on to you, the purchaser. You can pay them in full at the outset or add them to your mortgage repayments. It’s advisable, however, to talk to a mortgage broker or financial adviser about the best payment options.
How lenders calculate costs
Lenders charge different rates for LMI. Most mortgage providers have calculators on their websites, which you can use to compare rates when shopping around. LMI also comes with a stamp duty fee that differs from state to state.
To understand how much a policy will cost you, use a calculator. Simply key in the cost of the property and the deposit amount you have to put towards it. For example, say you’re buying a property for $400,000 in Victoria. You only have a 10% deposit, so you need to borrow the other $360,000 (90% of the property’s value) over a 20-year mortgage term. In that case, an LMI policy from Westpac would cost you $8790.
The more expensive the property and the less the deposit, the higher the LMI fee. So if you are looking to buy a $600,000 property in Victoria over 20 years with only a 5% deposit ($30,000), the fee Westpac charges for LMI jumps to $25,951.
What to consider
On the plus side, LMI does allow people to get a home loan and buy properties that might otherwise be out of reach.
Despite meeting your lender’s other prerequisites, such as stable employment and a good credit score, you might be unable to muster the required 20% deposit. FOMO (fear of missing out) can be a major driver in a red-hot property market where everyone’s diving in head-first.
This strategy can pay off well and truly when the market is buoyant. For example, say you bought the aforementioned $400,000 property five years ago with a 10% deposit, and it is now worth $700,000. In that case, you’d be a long way ahead, given that the LMI cost you less than $9000.
Having said that, house prices in Australia’s capital cities have been falling steadily throughout 2022, with only Darwin bucking the trend, thanks to interest rates rising relentlessly and ongoing global economic uncertainty. Under these circumstances, taking out LMI to buy a property instead of saving for a larger deposit seems counterintuitive.
Also, on the downside, it’s important to note that, as the property’s purchaser, you get no protection from LMI in a worst-case scenario, where your lender ends up selling your property because you can’t make repayments or resolve the issue of any other way.
Once the lender sells the property and there’s still, say, $50,000 owing on the loan — and it could be more if the market has taken a major downturn — the insurer will pay the lender that amount but then seek to retrieve the money from you. While most lenders will work with you as diligently as possible to avoid this situation, it does happen, especially during economic downturns.
Frequently asked questions
Yes. According to the Australian Taxation Office website, you can claim LMI as a tax deduction as a borrowing expense.
To avoid LMI, you’ll need to make a deposit of 20% or more.
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