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Understanding Mortgage Insurance

What is Lender’s Mortgage Insurance (LMI) and how does it work?

Lender’s Mortgage Insurance is an insurance policy that protects the lender from financial loss if the borrower can’t afford to meet their home loan repayments.

Under the terms that are included in most LMI policies, a financial institution can make a claim if the borrower defaults on the loan, and the sale of the property doesn’t equal the value of the mortgage. It might seem that there is a benefit to the borrower from LMI, but by reducing the risk to the lender, LMI allows them to lend larger amounts and approve more home loan applications.

Lenders mortgage insurance is applied directly to your home loan when it applies, so it’s not technically an upfront fee – but you still pay for it. How do you know LMI applies to you?

When is lenders mortgage insurance required?

Generally a lender will require you to pay for a lender’s mortgage insurance policy if your home loan deposit is less than 20% of the total value of your mortgage – however individual lenders may require more or less than a 20% deposit in order to avoid paying LMI.

This means that if you’re looking to avoid paying LMI, you may be better off not entering the housing market just yet, and waiting for a few years (or however long it takes) for you to save the 20% deposit required to avoid paying LMI.

What affects the cost of lender’s mortgage loan insurance?

There are a few things that affect the cost of LMI. These include:

1. The size of loan you want

The greater the amount of money you are borrowing, the greater the potential loss of the financial institution in the event that you default. Hence the bigger your loan, the higher the cost of insuring against it.

2. The amount of deposit you have

Research has found the deposit you can raise will impact the interest rate offered to you by the bank, but it will also affect how much LMI you have to pay, if any.

A number of home loan products and providers will lend up to 95% of the property value, whereas standard home loans typically require a deposit of 20%, and low doc home loans may require a deposit between 20% and 40% of the property’s value. There are even a very small number of no deposit home loan products out there.

The smaller the deposit you have though, the higher the cost of LMI.

3. Whether the property is for investment or to live in

Not all financial institutions will differentiate between an investment and residential property purchase when it comes to LMI, but some will.

4. Full-time or casual?

Your employment status can also affect the perceived risk of lending to you, so this is another factor that might affect your LMI premium.

5. The insurer used by the financial institution

There are several providers of lenders mortgage insurance and, just like any other insurance product, premiums can differ between institutions.