The idea of mortgage insurance is a fairly simple one – if circumstances mean a borrower can’t afford their mortgage repayments, an insurance policy can be used to help cover the costs.
One of the most common types of mortgage insurance that most Australians will encounter is Lender’s Mortgage Insurance (LMI).
It’s essential to remember that Lender’s Mortgage Insurance does not protect borrowers who take out home loans – LMI only protects lenders (e.g. banks, credit unions) that provide home loans. If you’re unable to afford your mortgage repayments, you don’t get any money from LMI – instead, the bank uses the policy to help minimise its financial losses.
A type of mortgage insurance that protects borrowers, not lenders, is Mortgage Protection Insurance (MPI), sometimes known as borrower’s mortgage insurance. This type of insurance works similarly to income protection insurance, in that if you’re unable to afford your home loan, the insurance policy will support you for a limited time until you’re back on your financial feet.
Unlike many other insurance policies, Mortgage Protection Insurance is generally offered by the bank or lender that also supplies your mortgage, rather than by a separate insurance company. However, only a limited number of lenders offer MPI.
Do you need mortgage insurance?
Depending on your personal finances and the structure of your mortgage, you may need Lender’s Mortgage Insurance to get your home loan application approved.
If your mortgage has a Loan to Value Ratio (LVR) of more than 80%, your lender will likely take out LMI to protect their finances in case you default on your repayments. This is because your lender would lose much more money if you were to default without a large enough deposit in place to secure your home loan.
It’s important to remember that even though Lender’s Mortgage Insurance protects the lender rather than the borrower, it’s usually the borrower who has to pay for it. Many lenders pass the costs of LMI onto borrowers, which can add thousands of dollars onto a home loan’s upfront costs.
It’s sometimes possible to borrow the money for LMI by adding it onto the cost of your home loan. However, this means paying interest on this amount over a long time, ultimately costing you more in total.
Mortgage Protection Insurance is not an essential requirement for every home loan, though some borrowers appreciate the extra security offered by MPI.
If you already have other insurance policies in place that offer similar benefits to Mortgage Protection Insurance, then MPI could be an extra expense that you may not ultimately need. For example, some life insurance policies may already offer financial support for your household should you be injured or incapacitated and unable to continue working.
Before considering mortgage protection insurance, it’s often worth looking at your current finances and comparing the available options. You may want to consider contacting a financial adviser for additional guidance.
What are the benefits of mortgage insurance?
As a borrower, Lender’s Mortgage Insurance may not sound like it offers you many benefits. If LMI only protects your lender, and you still have to pay for it, then what good does it do you?
The primary benefit of LMI for borrowers is that it can allow you to successfully apply for a mortgage from a bank or a lender even if you haven’t been able to save up a large deposit. While LMI is almost never cheap, it can sometimes be quicker and simpler to pay for LMI plus a smaller deposit of 10% or 5% your property’s value than to take the time to save up a deposit of 20% or more.
As for Mortgage Protection Insurance, its primary benefit is peace of mind. If you were to get sick or lose your job, you can be more confident that you won’t also lose your house. Depending on your circumstances, you may receive an income stream or a lump sum from your MPI to support you in your time of need.
Even if you already have an insurance policy that offers income protection, this may not pay out as much money as a dedicated Mortgage Protection Insurance policy, or last for as long a length of time, or apply in as great a range of circumstances. For example, while a life insurance policy may cover you if you are permanently disabled, or protect your family if you were to pass away, it may not apply if a less serious illness prevents you from working, or if you lose your job.
Always compare your available options and read the product disclosure statement and any other fine print before committing to an insurance offer.