What Is Lenders Mortgage Insurance (LMI)?
What Is Lenders Mortgage Insurance (LMI)?
Saving a 20% property deposit can take considerable time. Depending on the lender and your circumstances, you may be able to apply for a home loan with a smaller deposit, but this could mean paying Lenders Mortgage Insurance.
Lenders Mortgage Insurance, commonly referred to as LMI, is generally a one-off cost that protects the lender if a borrower cannot repay their home loan.
Although the borrower usually pays the cost, LMI does not insure or protect the borrower. Its purpose is to reduce the lender’s risk when approving certain home loans, particularly where the borrower has a smaller deposit.
Understanding how LMI works, how it is calculated and how it can affect your home loan may help you make a more informed decision about your property purchase.
What Does Lenders Mortgage Insurance Cover?
LMI protects the lender against certain financial losses if a borrower cannot meet their home loan repayments and the lender is unable to recover the full outstanding debt.
For example, if a borrower defaults on their home loan, the lender may eventually sell the property. If the sale proceeds are not enough to cover the outstanding loan and associated recovery costs, the lender may be able to make a claim under its LMI policy.
It is important to understand that LMI:
Protects the lender rather than the borrower
Does not make home loan repayments on your behalf
Does not protect your credit history
Does not provide income protection
Does not remove your repayment obligations
Is different from home, contents, life or mortgage protection insurance
LMI may make a lender more willing to approve an eligible borrower with a smaller deposit, but the borrower must still satisfy the lender’s income, expense, credit and serviceability requirements.
When Is LMI Usually Required?
LMI may be required when your loan-to-value ratio is above 80%.
This generally means you are borrowing more than 80% of the lender-assessed value of the property and have a deposit or available equity of less than 20%.
However, the exact point at which LMI applies depends on the lender, loan type, property and borrower’s circumstances. A 20% deposit does not automatically guarantee approval or mean LMI will never apply.
Likewise, some lenders may accept eligible borrowers with a smaller deposit under particular lending policies, products or guarantee arrangements.
Moneysmart states that borrowers with an LVR above 80% may need to pay LMI, although the final requirement is determined by the lender.
What Is a Loan-to-Value Ratio?
Your loan-to-value ratio, or LVR, compares the amount you are borrowing with the value of the property being used as security.
It is generally calculated using the following formula:
Loan amount ÷ property value × 100 = LVR
For example:
Property value: $700,000
Loan amount: $630,000
Deposit towards the property price: $70,000
LVR: 90%
In this example, the borrower is seeking to borrow 90% of the property’s value. Subject to the lender’s requirements, LMI may apply.
If the borrower instead contributed $140,000 towards the property price and borrowed $560,000, the LVR would be 80%.
The lender will generally calculate the LVR using its accepted value of the property. This may be the purchase price, the lender’s valuation or another amount determined under the lender’s policy.
If the lender’s valuation is lower than the agreed purchase price, the borrower may need to contribute additional funds or accept a higher LVR.
Does a 10% Deposit Mean a 90% LVR?
Not necessarily.
A deposit needs to cover more than just part of the property’s purchase price. Buyers may also need funds for expenses such as:
Transfer duty
Conveyancing or legal fees
Building and pest inspections
Loan application or settlement fees
Property valuation costs
Moving expenses
Adjustments at settlement
An emergency cash buffer
Unless another arrangement has been approved, these costs generally need to be paid in addition to the deposit.
For example, having savings equal to 10% of the property price does not necessarily mean the entire amount can be used as the deposit if part of those savings is needed to cover purchasing costs.
How Much Does LMI Cost?
There is no single fixed LMI fee that applies to every borrower.
The amount can depend on factors such as:
The amount being borrowed
The property’s value
The loan-to-value ratio
The size of the borrower’s deposit
Whether the property will be owner-occupied or an investment
The lender and mortgage insurer involved
The type of loan
The borrower’s circumstances
Whether the premium is paid upfront or added to the loan
As a general principle, a higher LVR may result in a higher LMI cost because the lender is taking on greater risk.
The cost can sometimes be several thousand dollars or more, particularly for a larger loan with a smaller deposit. However, any estimate should be treated as indicative until the lender has assessed the application and confirmed the applicable premium.
A mortgage broker can request an indicative LMI estimate when comparing eligible home loan options.
How Is LMI Paid?
LMI is usually handled in one of two ways.
Paid upfront
The borrower may pay the LMI premium at or before settlement together with the other purchasing and loan costs.
Paying the premium upfront means it is not added to the home loan balance, but it requires the borrower to contribute more money at settlement.
Added to the home loan
Depending on the lender and the maximum LVR permitted, the LMI premium may be added to the home loan. This is sometimes referred to as capitalising the LMI.
Adding LMI to the loan may reduce the amount that needs to be paid upfront. However, it increases the loan balance, which means interest may also be charged on the LMI amount for as long as it remains part of the loan.
The lender will determine whether capitalising LMI is available and whether the resulting loan remains within its maximum permitted LVR.
An Example of Capitalised LMI
Assume a borrower is purchasing a property for $700,000 and is approved to borrow $630,000 before LMI.
If the LMI premium were hypothetically $12,000 and the lender allowed it to be added to the loan:
Base loan amount: $630,000
LMI added to the loan: $12,000
Total loan amount: $642,000
The borrower would then pay interest on a loan balance that includes the LMI premium.
This example is for illustration only. It is not an estimate of the LMI that would apply to a particular property or borrower. The actual premium and amount that can be capitalised will depend on the lender’s assessment and applicable lending criteria.
Why Would Someone Pay LMI?
Paying LMI may allow an eligible borrower to purchase a property without waiting until they have saved a full 20% deposit.
Potential reasons for proceeding with LMI may include:
Purchasing sooner with a smaller deposit
Entering the property market before reaching a 20% deposit
Retaining some savings for purchasing costs or emergencies
Avoiding a lengthy delay while continuing to save
Purchasing a suitable property when it becomes available
However, proceeding sooner does not guarantee that the property will increase in value or that paying LMI will produce a better financial outcome.
The additional loan amount, interest, repayments and overall purchasing costs must still be affordable.
What Are the Disadvantages of LMI?
The main disadvantage is the additional cost.
Potential considerations include:
A higher upfront cost
A larger loan if LMI is capitalised
Additional interest if the premium is added to the loan
Higher regular repayments due to the larger balance
Less initial equity in the property
Greater exposure if the property’s value falls
The possibility of paying LMI again when refinancing
A smaller deposit also means you are borrowing a larger percentage of the property’s value.
This can leave less flexibility if you need to sell shortly after purchasing, particularly if the property’s value falls or selling costs reduce the amount available to repay the loan.
Can LMI Be Avoided?
There are several possible ways to avoid or reduce LMI, although availability and eligibility will vary.
Save a larger deposit
Increasing your contribution may reduce your LVR to 80% or below.
A larger deposit may also reduce the amount borrowed, repayments and total interest payable. Moneysmart notes that saving a larger deposit can reduce borrowing costs and may allow borrowers to avoid LMI.
Use available property equity
Existing homeowners may be able to use equity from another property towards a new purchase.
Available equity is not necessarily the same as usable or borrowable equity. The lender will still assess the property value, existing debt, proposed lending and borrower’s capacity to repay the loan.
Consider a guarantor arrangement
Some lenders may allow an eligible family member to provide a limited guarantee supported by their property.
A guarantor arrangement can involve substantial financial and legal risks for the guarantor. The guarantor may become responsible for the guaranteed debt if the borrower cannot meet their obligations.
Independent legal and financial advice should be obtained before entering into a guarantee.
Check eligibility for deposit-support programs
Eligible buyers may be able to access a government-backed deposit arrangement that allows them to purchase with a smaller deposit without paying LMI.
Eligibility requirements, property price limits, occupancy rules, participating lenders and other conditions may apply. Availability and requirements can also change, so current scheme information should be reviewed before relying on this option.
Compare participating lenders
Lenders can have different LMI requirements, maximum LVRs and credit policies.
A mortgage broker can compare suitable options through their lender panel and explain whether LMI is likely to apply. However, selecting a lender solely to avoid LMI may not necessarily produce the lowest overall loan cost.
Interest rates, fees, features, restrictions and eligibility requirements should also be considered.
Is LMI Refundable?
Paying off or refinancing a home loan does not automatically mean the borrower will receive an LMI refund.
A partial refund may be available in limited circumstances, depending on factors such as:
The lender and mortgage insurer
How long the policy has been active
The terms of the LMI arrangement
Whether the loan has had repayment problems
When the loan is discharged
Whether a refund request is made within the required period
When refinancing a loan with less than 20% equity, you may also be required to pay LMI on the new loan. This can increase the cost of refinancing and may outweigh the benefit of changing lenders.
Moneysmart recommends checking whether LMI will apply to the new loan and asking the existing lender whether any refund may be available.
Can You Transfer LMI to Another Lender?
LMI will not generally transfer automatically from one lender to another.
If you refinance and your new loan has an LVR above the new lender’s threshold, the new lender may require another LMI premium.
The previous LMI policy was arranged to protect the original lender. It does not necessarily protect the new lender or continue after the original loan is discharged.
This is why the potential LMI cost should be included when calculating whether refinancing is financially worthwhile.
Is LMI the Same as Mortgage Protection Insurance?
No.
LMI protects the lender against certain losses connected with the home loan.
Mortgage protection, income protection, life insurance and other personal insurance products are designed for different purposes and may provide benefits to the insured person or their beneficiaries, subject to the policy’s terms, exclusions and eligibility requirements.
Paying LMI does not provide personal insurance cover and does not replace the need to consider whether other insurance is appropriate for your circumstances.
Does Paying LMI Mean Your Loan Will Be Approved?
No.
LMI does not guarantee home loan approval.
The lender and, where applicable, the mortgage insurer will still assess the application. This may include reviewing:
Income and employment
Living expenses
Existing loans and liabilities
Credit card limits
Credit history
Available deposit and genuine savings
The property being purchased
The loan amount and LVR
The borrower’s ability to meet repayments
The lender’s current credit policies
An application may be declined even where the borrower is willing to pay LMI.
Pre-approval is also generally conditional and does not guarantee formal approval.
Is Paying LMI Worth It?
Whether paying LMI is appropriate will depend on the borrower’s circumstances and priorities.
It may be worth considering if buying sooner is important and the repayments, purchasing costs and additional LMI expense are manageable.
Alternatively, continuing to save may result in:
A larger deposit
A smaller loan
Lower repayments
Less interest over the loan term
A lower LMI premium
Avoiding LMI entirely
The decision should not be based only on the LMI amount. It is important to consider the complete cost of the proposed home loan, the time required to save a larger deposit and the risks associated with borrowing at a higher LVR.
Questions to Ask About LMI
Before proceeding with a loan that includes LMI, consider asking:
Why is LMI required for this application?
What LVR is the lender using?
What property value was used to calculate the LVR?
How much is the estimated LMI premium?
Can the LMI be added to the loan?
How will capitalising LMI affect my repayments?
How much additional interest could I pay?
Would a slightly larger deposit reduce the premium?
Are there suitable alternatives available through other participating lenders?
Could I be eligible for a deposit-support program?
Would LMI apply again if I refinanced?
Is any part of the LMI potentially refundable?
What other purchasing costs will I need to pay?
How much money will I have remaining after settlement?
How Can a Mortgage Broker Help?
LMI requirements can vary between lenders, which means it is important to assess more than one option where appropriate.
A mortgage broker can help by:
Calculating your estimated LVR
Explaining why LMI may apply
Requesting indicative LMI estimates
Comparing suitable options available through their lender panel
Reviewing how different deposit amounts may affect the loan
Explaining whether the LMI can be capitalised
Comparing rates, fees and loan features
Checking whether alternative lending policies may be available
Assisting with the loan application and supporting documents
The lowest LMI premium does not automatically mean the lowest-cost or most suitable loan.
A broker can help compare the broader loan structure, including the interest rate, comparison rate, fees, features, repayments and estimated total cost.
Speak With Homefront Mortgages
Having less than a 20% deposit does not necessarily mean you must delay your property plans.
Homefront Mortgages can review your deposit, estimated purchasing costs and borrowing position before comparing suitable home loan options available through our lender panel.
We can explain whether LMI may apply, provide an indicative estimate where available and help you understand how it could affect your loan balance and repayments.
We do not represent every lender or home loan available in the market. The final decision to approve a loan, including any LMI requirement, loan amount, interest rate and applicable conditions, is made by the lender and, where relevant, the mortgage insurer.
Important Information
This article provides general information only and does not constitute personal financial, tax, legal or insurance advice. It does not take into account your objectives, financial situation or individual needs.
Before acting on this information, consider your circumstances and obtain appropriate professional advice.
Loan approval is subject to lender assessment, eligibility requirements, satisfactory documentation, property valuation and applicable lending criteria. LMI requirements, premiums, lending policies, interest rates, fees, terms and conditions vary between lenders and may change. Fees and charges may apply.
Any examples are illustrative only and do not represent an offer, quotation, approval or estimate of finance or LMI.
