Lenders Mortgage Insurance | How to reduce your premium
In most situations, you will pay lenders mortgage insurance if you don’t have a 20% deposit when applying for a home loan. It’s usually one of the most expensive costs of buying a home.
Here I explain what it is and the easy ways to either reduce the cost of the insurance premium or avoid paying it altogether!
For many years now I’ve been helping my clients reduce (and avoid) the amount of lenders mortgage insurance (LMI) they pay.
Most of the time I can save them several thousands of dollars in LMI.
The better option is to avoid paying it altogether, however, unless you have a 20% deposit to a buy a home, the chances are you will need to pay some LMI.
Before I get into ways to avoid or reduce lenders mortgage insurance, I’m going to cover some of the basics like what it is and why banks make their clients pay it.
The basics on lenders mortgage insurance:
What is Lenders Mortgage Insurance (LMI)
Lenders mortgage insurance (LMI) is a one-off payment that you make when you take out your home loan.
This insurance is there to protects the bank or lender, though it’s paid by you upon settlement.
It’s different from your car or home insurance, where you are protected if you have an accident or your home is damaged in a storm.
The foundation of working out the cost of LMI is knowing another 3 letter finance acronym: the Loan to Valuation Ratio (LVR).
The lender requires you to pay LMI if you’re borrowing 80% of the value of your property (i.e you have a 20% deposit) because they consider you to be a risky borrower.
When do I need to pay lenders mortgage insurance
Lenders mortgage insurance (LMI) is a one-off fee and it’s paid on the settlement of your home loan and it lasts for the life of your loan which is typically 30 years.
In saying that though, it’s important to know upfront that if you buy a home today but are planning on renovating your home in 3 years time, you may also pay LMI again when you do a loan increase for the renovations.
LMI is usually compulsory with most lenders where your deposit is less than a 20% deposit of the value of your home.
Some lenders allow you to have a 15% deposit without paying LMI as a special promotion (though they normally offer this for clients who meet a very specific set of criteria).
If you’re lucky enough to have a bigger deposit (of 20% or higher) then it’s likely you won’t be charged lenders mortgage insurance.
The reason for this is that banks / building societies and credit unions have found that once a client has paid a 20% deposit for a home they have a much lower risk of the lender losing money on that loan – the risk of the borrowers not making their payments on time is lower and if for some reason the bank has to sell the property to recover their money then having the owner’s 20% buffer gives them a much higher chance of them being paid their loan in full.
We find that the 3 most common groups of clients who will need to pay LMI are as follows:
- Families who are buying / building their first homes;
- People who are buying their first investment property;
- Families who are doing a major renovation to their home (i.e. adding another bedroom, installing a new kitchen and renovating their bathroom(s).
You can pay the cost of your LMI in either of two ways:
- It can be added to your home loan which is known as capitalising your LMI, or
- Pay for it using part of your house deposit.
(*In the 10 years since I started being a mortgage broker in 2007, I’ve only had one time where it didn’t work out better for our clients to capitalise the cost of the LMI to their home loan rather than if they pay it out of their deposit.)
Do I need to pay LMI if I’m buying an investment property, vacant land or building?
Yes, LMI needs to be paid on most loans where you’re borrowing more than 80% of the value of the property.
This includes when you’re buying an investment property, vacant land or building a home.
How is lenders mortgage insurance calculated?
The amount of LMI you need to pay will vary depending on 3 things;
- The amount of the loan.
- Which lender you are taking out the loan with.
- The loan to valuation ratio of the loan that you’re borrowing.
I cover this in more detail below.
How to avoid or reduce paying Lenders Mortgage Insurance
How can I avoid paying Lenders Mortgage Insurance altogether?
These are the four ways to avoid paying LMI:
#1: Have a 20% deposit:
- If you don’t have at least a 20% deposit, and you don’t meet one of the other three criteria below, then you will pay LMI.
- For example, you would need at least $100,000 as a deposit if the home you’re buying is worth $500,000.
- It’s important to remember that if you’re building your first home, you can include the Queensland Government Building Grant as a part of your deposit (at the moment this is $20 000).
#2: Work in certain professions:
- If you work in certain professions accepted by the lenders, then you only need to pay a 15% deposit to avoid LMI.
- These are: lawyers, solicitors, accountants, doctor, pharmacist, anesthetists, dentist, physiotherapists, surgeons to name a few.
- Keep in mind that you may need to meet other criteria to get this deal and there will often be conditions to the loan as well.
#3: Having help with a family guarantee:
- This is where a family member has sufficient equity in their home or investment property and they want to help you out with buying your home.
- The family member then commits to provide the required equity as a security guarantee.
- For example, if you have 10% as a deposit yourself, then your family can provide the remaining 10% to make up the required 20% to avoid paying LMI.
#4: Get a loan ‘special promotion’
- From time to time some lenders will run promotions to target a certain type of loan. The most common promotion is to reduce the threshold to 15% rather than the 20% (i.e. if borrowing $500,000 you need a $75,000 deposit instead).
- Citibank are one of the lenders that offer this the most consistently.
- There are often other requirements to take this promotion, such as you need to pay principle and interest repayments (rather than interest only), they charge a higher interest rate on these loans and they restrict the type of property and the postcode that you’re buying in.
How can I reduce the amount of LMI I am paying?
For many people, it’s really challenging to save the full 20% deposit to avoid paying LMI – especially when you’re buying your first home.
For example, let’s say you’re buying your first home and it’s a 3 bedroom Queenslander in Greenslopes at a price of $620,000.A 20% deposit on this property would be $125 000. You would also need to cover the cost of buying (stamp duty, solicitor’s fee’s etc which can be considerate).
A deposit of $125,000 (plus the cost of buying) can be really difficult to save.
The good news is, if you have less than a 20% deposit, there are still ways you can save money by reducing your LMI premium.
The two big ways I reduce LMI are:
#1. Find an LMI sweet spot (this is the main one):
- When I run different deposit / loan amounts I find the sweet spot, which is where if a client reduces their loan by a small amount (a few thousand dollars), their LMI premium also drops by more than a few thousand dollars. I cover this one in more detail below.
#2. Consider using other lenders with lower LMI premiums:
- All lenders charge different premiums so you could save several thousand dollars difference.
#3: Don’t cross collateralize your loans
- If you have loans for both your home and your investment property, don’t have them both with the same lender.
#1: Find an LMI sweet spot: How to save on lenders mortgage insurance
This little gem, which I call, ‘LMI Sweet Spots’ came about after analysing lots and lots of different LMI quotes and scenarios for clients to work out how to save them money on their LMI premium.
What I discovered was that in certain circumstances, if you increase your deposit by a small amount (and hence decrease how much you borrow), it can make a really big difference in the cost of LMI.
I’m not talking about increasing your deposit by $20,000 – most people wouldn’t be able to save or find that amount of money quickly!
Instead, I’m talking about increasing your deposit by few thousands of dollars to save double that!
The best way to show you this is through the chart below. If you aren’t a graph or numbers person, don’t be put off. I’ll take you through a simple example.
The loan amount is the blue bar.
The lender’s mortgage insurance payable at that loan amount is shown by the orange line.
You can see that I have highlighted three sections in orange, yellow and green.
These are some examples of ‘sweet spots’ where you can save on your lender’s mortgage insurance.
The best sweet spots happen at LVR’s of 88%, 90% and 92%.
Let’s look at a scenario where we recommend an LVR of 90%.
#Scenario 1 (green): LMI premium reduced, saving the client $4,220
A client comes to me wanting to buy a home for $480,000.
They have a deposit saved of $43,200, so they need to borrow $436,800 with an LVR of 91% (read about LVR’s in the callout box above).
At this deposit and loan amount, the LMI they need to pay is $13,500.
Purchase price (loan + deposit): $480,000
Loan amount: $436,800 (LVR of 91%)
Deposit: $43,200 (9%)
LMI premium payable: $13,500
Total loan amount (Loan + LMI) $450,300
Repayments on loan (weekly)* $526
After running these scenarios with a client to investigate we can show what the repayments and lmi cost would be if they have a slightly larger deposit ($4800 in this case). Now that they understand how it works and how their repayments would be lower they can see if it’s worth waiting a little bit longer for their savings to increase.
Purchase price (loan + deposit): $480,000
Loan amount: $432,200 (LVR 90%)
LMI premium payable: $9,280
Total loan amount (Loan + LMI) $441,480
Repayments on loan (weekly)* $515
This means their deposit needs to be $48,000 (not $43,200).
This reduced their LMI premium to $9,280 (saving them $4,220).
By putting in the extra $4,800 in deposit, this client ended up borrowing $8,820 less overall (extra deposit of $4,800 + LMI saving of $4,220).
*** Borrowing less means their repayments are also $11 less per week. So let’s say you took out the second option but paid the $526 in repayments – this means you will pay your loan off 1 year and 4 months sooner than you would have otherwise.***
Wrap up: It’s worth considering different LVR’s (deposit to loan ration) to see how tweaking a few numbers here and there can actually save you several thousand in LMI. You will also reduce how much you borrow and lower your loan repayments overall.
Scenario’s 2 and 3 coming shortly in bonus material!
*Based on principle and interest repayments at an interest rate of 4.5% over 30 years.
#2. Consider using other lenders with lower LMI premiums: how to save on your LMI premium
Simply by changing lenders, you can save hundreds.
Looking at the table below, this client wanted to buy a home worth $500,000.
They had a $95,000 deposit, so wanted to borrow $405,000 (LVR 81%).
If this client took their loan out with Commonwealth Bank, the LMI premium would be $2,302.
The cheapest LMI premium is with Heritage Bank at $2,147 and the highest is $2,349 which is offered by several lenders including AMP and Bank of SA.
How does LMI protect the lender
If you stop making your loan repayments, the lender will take ‘possession’ of your property (this term is known as ‘mortgagee in possession’) and sell it to regain the money they loaned you.
Sometimes, there is a shortfall between what the property sells for, and what you owe the bank.
In order to sell your property, your lender will have to pay a number of fees and expenses: real estate agent and legal fees, which the lender needs to cover.
In this situation (when the lender is out of pocket), the lender will claim on your Lenders Mortgage Insurance to protect them from losses.
Who provides LMI?
There are 2 main providers of LMI in Australia, or alternatively, some lenders provide their own LMI as well.
Two main providers of LMI:
- Genworth (sometimes referred to as GE): for example: The CBA, NAB, Bank of Queensland and Westpac use Genworth as their mortgage insurer;
- QBE Insurance: (Used by ANZ, Suncorp and BankWest.)
Each of these providers can have different policies relating to how and who they provide mortgage insurance too and the rates that they charge.
The LMI premium you pay is worked out between the insurance providers and the lender you are borrowing with.
This is why LMI premiums can vary by up to thousands of dollars.
Or alternatively, some lenders provide their own insurance (they will call it a different name but it essentially serves the same purpose ) and again there are large variations in what premium they charge (up to several thousand dollars).
When we’re recommending suitable home loans for your situation we are also taking into account the cost of the LMI as well.
My name is Victor Kalinowski, and I’m a Mortgage Broker at Blackk Finance, based in Brisbane. If you are interested in getting in touch, email me at [email protected] or call the office Monday to Friday on 07 3122 3628.
The information contained within this page is general in nature. It serves as a guide only and does not take into account your personal financial needs. Before you act on this information you should seek independent legal and financial advice. Copyright Blackk Finance 2017.