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The costs of home loan insurance

The costs of home loan insurance

These days it feels like we need insurance for everything. It’s one of those things, we often don’t realise we need until it’s too late. Lender’s Mortgage Insurance on the other hand, is not an optional insurance but instead a compulsory insurance some lenders enforce onto borrowers whom they consider a higher risk customer.

What is lenders mortgage insurance?

Home loan insurance, otherwise known as lenders’ mortgage insurance (LMI), protects your lender in the event that you default on your home loan and the property is repossessed and sold. This insurance covers the gap if the sale price is not enough to pay off the loan, meaning that the lender avoids a loss.

Contrary to what some believe, this means that lender’s mortgage insurance doesn’t protect the borrower.  You’ll have to take out a separate insurance policy for that.

What types of loans need home loan insurance?

Usually, you will need to pay for lenders’ mortgage insurance if your deposit is less than 20 per cent of the loan amount. The types of home loans that LMI covers is comprehensive, and includes owner-occupied, investment, construction, interest only, low doc loans, as well as many others.

It’s also important to note that borrowers who refinance and don’t meet the minimum required equity, may still need to pay LMI, even if refinancing for the same property! That’s because LMI is not transferrable or portable, it’s a one-off payment.

What’s in it for me?

Paying for LMI is a safeguard for your financial institution, meaning that they are more likely to approve your loan, and with much smaller deposits.

Therefore, instead of saving $100,000 for a $400,000 loan, those who pay for LMI may be eligible for a loan after saving only $20,000 (5 percent) for instance.

The clear danger here is that people may be taking on debt before they are ready to do so. To avoid this pitfall, home loan applicants usually undergo rigorous credit checks in order to prove their potential.

How do I pay for LMI?

Mortgage insurance usually comes in the form of a fee, paid once the loan is settled. The lender will then set up the insurance without too much hassle and paperwork.

If the financial crisis has taught us anything, it is that we should never borrow above our means. Saving up a while longer and putting down a sizeable deposit will reduce your repayments and the likelihood that you will undergo hardship if your circumstances change. Of course it can also save you thousands of dollars if you don’t have the added cost of paying LMI!

Crunch the numbers to work out how you can avoid lenders’ mortgage insurance by using the RateCity home loan comparison and home loan repayment calculator tools.

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Learn more about home loans

What is Lender's Mortgage Insurance (LMI)

Lender’s Mortgage Insurance (LMI) is an insurance policy, which protects your bank if you default on the loan (i.e. stop paying your loan). While the bank takes out the policy, you pay the premium. Generally you can ‘capitalise’ the premium – meaning that instead of paying it upfront in one hit, you roll it into the total amount you owe, and it becomes part of your regular mortgage repayments.

This additional cost is typically required when you have less than 20 per cent savings, or a loan with an LVR of 80 per cent or higher, and it can run into thousands of dollars. The policy is not transferrable, so if you sell and buy a new house with less than 20 per cent equity, then you’ll be required to foot the bill again, even if you borrow with the same lender.

Some lenders, such as the Commonwealth Bank, charge customers with a small deposit a Low Deposit Premium or LDP instead of LMI. The cost of the premium is included in your loan so you pay it off over time.

Will I have to pay lenders' mortgage insurance twice if I refinance?

If your deposit was less than 20 per cent of your property’s value when you took out your original loan, you may have paid lenders’ mortgage insurance (LMI) to cover the lender against the risk that you may default on your repayments. 

If you refinance to a new home loan, but still don’t have enough deposit and/or equity to provide 20 per cent security, you’ll need to pay for the lender’s LMI a second time. This could potentially add thousands or tens of thousands of dollars in upfront costs to your mortgage, so it’s important to consider whether the financial benefits of refinancing may be worth these costs.

How can I avoid mortgage insurance?

Lenders mortgage insurance (LMI) can be avoided by having a substantial deposit saved up before you apply for a loan, usually around 20 per cent or more (or a LVR of 80 per cent or less). This amount needs to be considered genuine savings by your lender so it has to have been in your account for three months rather than a lump sum that has just been deposited.

Some lenders may even require a six months saving history so the best way to ensure you don’t end up paying LMI is to plan ahead for your home loan and save regularly.

Tip: You can use RateCity mortgage repayment calculator to calculate your LMI based on your borrowing profile

How do I know if I have to pay LMI?

Each lender has its own policies, but as a general rule you will have to pay lender’s mortgage insurance (LMI) if your loan-to-value ratio (LVR) exceeds 80 per cent. This applies whether you’re taking out a new home loan or you’re refinancing.

If you’re looking to buy a property, you can use this LMI calculator to work out how much you’re likely to be charged in LMI.