What is LMI?
A common question is, What is LMI?
LMI protects the lender (not the borrower), should a home loan go into default and the lender needs to sell the property to clear the debt. The policy guarantees the loan will be fully repaid from either the sale of the property or the LMI policy that has been taken. There is no cover for the you, the customer. It IS NOT to cover for injury or illness, it solely covers the bank. This is even though you have to pay for the LMI cover.
Depending on the loan type, lenders will generally require LMI when there is less than a 20% deposit. A 20% deposit provides lenders a good buffer against any potential reduction in property value. LMI is another way lenders ‘in theory’ cover the 20% buffer. The LMI policy is acquired, which the borrower pays for. This means the borrower can purchase property with a smaller deposit.
How to buy without a 20% deposit
When you consider that a 2 bedroom unit could cost half a million dollars at the moment, saving the required 20% deposit to buy that unit would be $100,000. For most, an insurmountable task. That’s where Lenders Mortgage Insurance (LMI) can help. LMI may be an added expense, but enables you the opportunity to purchase earlier, without the need to save the full 20% of the purchase price.
What’s in it for you?
For you, it seems like LMI is just another added expense. However, LMI can mean that some buyers will be able to purchase with only a five per cent deposit (depending on the lender). In the example above, a $500,000 property, this brings the deposit down from $100,000 to just $25,000.
If the market is rising rapidly, paying LMI now and buying the property before any price increase could be cheaper than taking the additional time to save a bigger deposit and paying a higher price. In the time it takes to save a bigger deposit, property prices may well have increased by more than cost of the insurance would have been. This means for some properties and purchasers, it can make good financial sense to purchase earlier even with the added cost of LMI. This is especially when you consider the rent that you may be pay while you’re saving.
What you need to know
The insurance premium is usually a one-off payment when you take out the loan. Some lenders may allow you to add the cost to the loan. This would depend on the lender and the deposit you have. Just remember however, this also means you are paying interest on the LMI premium. There is also a big difference between premiums paid depending on the amount of deposit you have. A 10% will mean an LMI premium cost will be much less than a 5% deposit. It may well be worth trying to gather together some extra funds, even if you aren’t able to have the full 20 per cent.
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