Buying a property without a chunky deposit could see you whacked with the oft-dreaded cost of Lenders Mortgage Insurance. But in a different sense, the time it takes to save up the deposit could also cost you.
While some say good things come to those who wait, others say the early bird catches the worm.
In the context of buying property in Australia, those who wait to buy property until they’ve saved up a sizeable deposit can save money by not having to pay for Lenders Mortgage Insurance (LMI). But the early birds who buy property sooner after saving the bare minimum 5% deposit have the opportunity to catch their dream house before prices rise, and potentially build a capital gain as their property value increases in a rising market.
These early birds will probably have to pay for Lenders Mortgage Insurance, but perhaps this cost is worth it? Statistics suggest many borrowers might think so, since around one-quarter of Australian housing loans are estimated to be covered by LMI (according to the RBA).
Or maybe many of these borrowers don’t understand what Lenders Mortgage Insurance actually is? In 2016, Banking Analyst Martin North from Digital Finance Analytics told ABC News that around 70% of households think Lenders Mortgage Insurance covers them, which is incorrect.
So this begs the question…
What is Lenders Mortgage Insurance?
Lenders Mortgage Insurance (LMI for short) is an insurance policy which covers the mortgage lender against any loss they may occur in the event that the borrower can no longer pay loan repayments (an event known as a ‘default’ on the home loan). This is not to be confused with mortgage protection insurance, which covers borrowers for their mortgage in case of death, sickness, disability, or unemployment.
If a borrower defaults on their mortgage, the lender can recover what is owed to them by repossessing the property which the home loan is tied to. But if the property’s value has fallen, the lender can suffer a loss. This is the risk which LMI covers. With this risk of loss passed on to the Lenders Mortgage Insurer, lenders are more willing to approve loans at a higher loan-to-value ratio (LVR), often up to a maximum of 95% of the property’s value or sale price (whichever is lower).
The introduction of Lenders Mortgage Insurance to Australia in 1965 thus created more opportunities for people to get a home loan and also encouraged lenders to charge lower interest rates. The two largest providers of LMI in Australia are:
- Genworth Financial
The lender decides which LMI provider to go with – the borrower has no choice in the matter.
While LMI only covers the lender, it is usually the borrower, not the lender, who has to pay for it. For many, paying for an insurance policy that only covers a financial institution seems like the worst form of charity. So what does it take to avoid it?
Deposit requirements to avoid Lenders Mortgage Insurance
Typically, lenders exempt borrowers from having to pay for Lenders Mortgage Insurance if the deposit on the property is over 20% (80% LVR) of the property’s value or sale price (whichever is lower). This is because lenders perceive borrowers with deposits over 20% as less likely to default on a loan. Also, a 20% deposit is viewed as a large enough buffer to protect lenders from a fall in the value of the property – giving them a strong chance of recovering the amount that’s owed to them if the borrower defaults.
Some circumstances may require a larger deposit though. In specific suburbs that a lender perceives as having high default rates and / or at risk of a large fall in prices (eg. like what was seen in some of the regional mining towns when the capital infrastructure boom ended), the lender may require a bigger deposit (such as 30%) for the borrower to be exempt from LMI.
— TEN Eyewitness News (@channeltennews) October 22, 2016
Other ways of avoiding Lenders Mortgage Insurance
Borrowers can be exempt from having to pay LMI for other reasons, such as:
- Having a guarantor: Many lenders will waive LMI on the loan (no matter how small the deposit) if the borrower is backed by a quality guarantor (such as a parent) that legally accepts responsibility for the mortgage repayments if the borrower cannot make them.
- Working in a highly-regarded profession: Borrowers working in specific professions that are considered to be highly paid and relatively stable can sometimes borrow up to 90% LVR without having to pay LVR. Such professions can include:
- Doctors (GPs, dentists, optometrists, GPs)
- Accountants (e.g. actuaries, CFOs, auditors)
- Lawyers (e.g. solicitors, judges, barristers)
Sometimes a combination of other factors can also see LMI waived on the home loan, such having a perfect credit history and requesting a modest loan amount for property in a low-risk suburb.
How to pay Lenders Mortgage Insurance
LMI premiums can be paid as an upfront once-only fee at settlement (loan drawdown).
Alternatively, they can be capitalised into the loan (added to the loan amount) and gradually paid off in the regular mortgage repayments. This means the premium will accrue interest though, costing you more over the long term.
Cost of Lenders Mortgage Insurance
The upfront cost of LMI premiums typically varies by the size of the loan and the LVR, as illustrated below. They can also depend on what type of borrower you are. For instance, first-time borrowers often pay a higher LMI premium than existing borrowers, even at the same LVR and loan size.
|Estimated Lenders Mortgage Insurance (LMI) Premiums for First Home Buyers|
|Estimated property value||95% LVR||90% LVR||85% LVR|
Source: Genworth LMI premium estimator. Prices including GST but excluding stamp duty. Based on a loan term up to 30 years
Can you get a refund of Lenders Mortgage Insurance premiums?
When you refinance to a different lender or buy a new house, it’s unlikely that you’ll get this premium back. You may even have to pay for LMI again if your LVR is still above 80%.
However, in cases where the loan is terminated early (i.e. in the first two years), you may be eligible for a partial refund of LMI premiums. Qualifying for an LMI refund also depends on the lender’s LMI policy provider and meeting certain criteria, so it’s worth checking with your lender to see if you’re eligible.
Case Study: Brianna’s LMI dilemma
Brianna has $40,000 in savings and wants to buy a $400,000 property. Her $40,000 in savings would be worth a 10% deposit, putting her LVR at 90%. This would see her charged an LMI premium of around $7,000. Brianna could save herself from having to pay this $7,000 by waiting till she’d saved up a 20% deposit ($80,000). At her current wage and expenses, she’s saving $20,000 per year, so this would take her two years to save up a total deposit of $80,000. Brianna might decide it is worth the two-year wait to save $7,000.
But what if the property’s value is increasing at a rate of 5% per annum? By the time Brianna has saved up the $80,000, the property would be worth $441,000 and Brianna’s $80,000 would be worth only 18%. Had Brianna bought the property two years’ earlier with just her 10% deposit, she could’ve paid off a significant portion of her loan and earned $41,000 in unrealised capital gains. In that case, the cost of LMI seems worth it.
The Savings Tip
LMI is a tricky one, because you could save either way. Without it, you obviously save money by not having to pay premiums. But if property value increases during the time it takes you to come up with a 20% deposit, you could pay more on the purchase price than you would have if you’d snapped it up back when you just had a 5% deposit. You may even be shocked to discover that because prices have risen, what you thought was a 20% deposit is now only worth 15%. That’s not to mention the intangible emotional costs that can come with having to wait longer – such as missing out on the chance to buy that dream house you’ve always loved that’s rarely been put on the market.
Of course with LMI, you’re paying thousands for insurance that doesn’t provide any cover to you, which can seem like a big waste of money.
Perhaps then its best to aim to have at least a 20% deposit, but be willing to buy with less and bear the cost of LMI in special cases where:
- you’re very confident the property’s price will rise significantly enough in the near future to outweigh the additional cost of LMI; or
- it’s your dream house (you have a strong emotional connection to it) that you intend on living in long-term and you don’t think you’ll get another chance to buy it in the near future.