With all of the text abbreviations in use these days you might be excused for double-taking on LMI and wondering what it stands for and why it’s even being mentioned when you see it come up in regards to securing your first home loan.
LMI stands for Lenders Mortgage Insurance and it was designed to give people a chance to buy property with less saving, thus hopefully securing the great Australian dream of owning a house for the next generation.
So let’s get in to this what, where, and why.
The What of LMI
Lenders Mortgage Insurance is a type of insurance that a lender (your bank, broker, or independent lender) takes out to insure themselves against, well, you and the risk of not recovering the outstanding loan balance from you. How unsavoury does that make you feel?
Don’t be offended, everyone is so testy these days. This is just in the event that you are unable to meet your loan repayments and cannot come to any other arrangement with your lender, thereby activating a foreclosure (a forced sale of your house). If this occurs and, heaven forbid, the property is sold for less than the outstanding balance of your loan, you will find yourself indebted to the bank for that remaining amount and taking out insurance is a lot easier than filing for bankruptcy. I refuse to highlight that word, I feel like we have already been through enough.
Insurance, fine you say, I get “insurance”, it’s there to protect me. Yes, you are right, and traditionally insurance is paid for by the party requiring the insurance, but not so in the case of LMI — this is the lenders insurance against you defaulting. They, the lender, require it as part of your loan arrangement but guess what? You get the pleasure of paying for it!
It might sound cruel and unfair that you have to pay for an insurance you can’t actually claim against but, as is the case of most major insurances, it’s not about the little payouts, it’s about the worst case scenario. Would you want to t-bone a Tesla without insurance?
Still feeling unsure? Here’s an example:
If you buy a property for $600,000 and after three years, due to some unforeseen calamity, you cannot pay that mortgage, the lender will force a sale to recoup the remaining amount owed to them by you, therefore closing out the loan and ending your contract with the bank or lender.
If the property’s value has fallen to $550,000 with $500,000 still owed on the mortgage, LMI will make up the $50,000 difference. So hypothetically if you had paid $10,000 in insurance, you are still up $40,000.
While house prices in Australia’s capital cities fell steadily throughout 2022, with only Darwin bucking the trend (just because they’re a territory they think they have to be different). However, they have picked up again across the majority of the country over the last year, even with the instability of interest rates and ongoing global economic uncertainty but...
Imagine if prices drop suddenly. The world is uncertain at the best of times and if 2020 taught us anything, it’s that things can go south fast. So in conjunction with a sudden downturn in property, perhaps you lose your main source of income. Can you start to see the genuine importance of protecting yourself?
I hate to be all doom and gloom but as stated, this is a “written off Tesla” situation and yet, you might still be asking why would you fork out money for an insurance that you may not even need. Is that a tautology? Keep reading.
The When of LMI
This one is pretty simple. You will require LMI to get you across the line and secure your loan when you do not have a 20% deposit saved and are unable to cover the short fall with the help of a guarantor (aka the Bank of Mum & Dad).
LMI is as a one-off, upfront cost paid and hey, you get these free steak knives along with it! Nope, sorry, I was thinking of something else.
You will pay the fee to the lender at the time of the settlement, the lender then forwards this to the insurer, and voila! This policy is set in stone for the life of the mortgage, regardless of its length.
There is an option to add this fee to your mortgage repayments but increasing your loan amount to cover that will increase the interest you pay, so it’s advisable to talk to a mortgage broker or financial adviser about the best payment option for you.
It’s definitely worth noting that if you find yourself refinancing down the track, the LMI you paid only covers your initial loan. If you refinance, the new lender will make another assessment of the riskiness (*shuffle eyes side to side, rub hands together*) of this new loan, so it won’t matter if you’ve already paid the LMI.
Hopefully though, in this scenario, you have managed to pay off enough of your loan that the LVR (loan to value ratio) of the new loan is now below 80% so you’ll be in the clear and won’t be charged again. What if the LVR remains above 80% though? You will most likely need to pay for LMI twice... how boring is that?
Alternatively, you could go the other way and try decreasing the LVR by increasing the value of your property, perhaps through renovations and home improvements? A good example of this would be adding off-street parking through a driveway extension or sacrificing some yard space (if you are lucky enough to have the space to do so in the first place). I suggest rewatching The Castle for further inspiration in the home renos category.
The Why of LMI
If we add up the when and the when, we get the why.
In Australia, LMI was first introduced by the Housing Loans Insurance Corporation (HLIC) in 1965 and was established by the Australian Government under Menzies. It was introduced as a way to help more Australian people purchase their own home by using a smaller deposit.
It’s a sliding scale and different lenders charge different rates for LMI. It’s an easy thing to find out as most mortgage providers have calculators on their websites that you can use to compare rates when shopping around.
Some have called LMI a topic so dry that it requires sauce. So let’s see if I can add some.
LMI — The Sweet Spot
The beauty of LMI is that there is indeed a sweet spot — that place perfectly in balance.
LMI allows people to secure a home loan and buy a property that might otherwise be out of reach, and, if you have done your research and you get in at the right time, this might just mean you get up on the board and catch the wave all the way to shore. Timing is everything. I can practically hear your chairs creaking as you all lean forward in your seats and ask, “so how do I find this ‘sweet spot’?”
Well, if there was a formula, I would tell you. This is not to say that I believe it’s luck. It’s research. but mostly. it’s perseverance, which is ultimately the exact strategy you need for savings.
Did we just hit a grey area? I think we did, because chances are if you are looking at LMI as an option, a good savings record might not be your strong point. This is what the lenders feel about you. Let’s not prove them right.
By purchasing a property earlier with a smaller deposit, you potentially gain access to the property’s capital growth sooner. This means that any increase in the property’s value benefits you as the homeowner, potentially totally offsetting the cost of LMI over time and giving you equity in your property quickly, which can be used for renovations, further increasing your equity or potentially helping buying an investment.
This is definitely the flip-side of a foreclosure — that idea that somewhere out there, there is still that goose that lays the golden egg.
What we need to talk about is savvy investment. Saving for a 20% deposit could take years, during which time property prices are likely to continue to increase, making it even more challenging to save the required 20% amount, and now that you know that LMI allows you to bypass this delay and secure a property sooner, why wouldn’t you just jump in ASAP?!
Being savvy means not being fuelled by fear and rushing into the property market. It’s understandable that your brain is telling you that if you don’t do it now, or yesterday, or you are already too late, you will miss out entirely.
Heed this warning: Don’t just buy something now because you can with LMI. If you are saving for your first home, remember that it’s going to be your home for the foreseeable future. You are moving out of the rental market so you can’t just up and move if you make the wrong decision. You are going to wake up in this place every day and potentially begin your family here so don’t be hasty, just know that LMI will grant you that wish when you find an opportunity that you can’t pass up on, where you actually want to live, and while you are still short of your 20%. Yes I know they’re slightly different “w” words but you get my drift.
Everything in life is, or should be, about informed decision making. Good luck!
