JoshIf you’ve paid less than 20% on your home loan deposit, then it’s almost guaranteed you’ve paid Lenders Mortgage Insurance (LMI). Sure, it’s a pain, but at least it protects you in case you default on your mortgage, right? Wrong.
Unfortunately, this misunderstanding is an all too common scenario. In the excitement of buying a new home, borrowers skip through that crucial small print and head straight for the signature box, without realising they’re not protected. In this article, we’ll let you know what LMI is, how it’s different from other mortgage insurance options, and all the relevant details you need to know to ensure you’re covered.
Lenders Mortgage Insurance (LMI)
Lenders Mortgage Insurance is a product that provides protection to the lender, not the borrower (i.e., you!). Should you default on your loan, the bank will place your property on the market. If the sale price does not match the initial purchase price, this results in a ‘shortfall,’ meaning a financial loss for the bank. Lenders Mortgage Insurance (LMI) covers this amount; however, this doesn’t necessarily end your involvement, as the insurance company may attempt to recoup their losses either from yourself or your guarantor (should you have one).
Will I need to pay Lenders Mortgage Insurance?
This question is difficult to answer, as lenders assess each individual mortgage situation differently. However, the general rule of thumb is as follows: if you chalk up 20% or more of the total value of the home as a deposit (i.e., your Loan to Value Ratio, or LVR, is less than 80%), you have nothing to worry about. Otherwise, you’ll have to pay the fee. While this may seem a little unfair, it’s worth bearing in mind that this type of insurance allows banks to lend funds to those who cannot afford a large deposit amount. In effect, this insurance type widens access to potential buyers.
How much does LMI cost? When do I need to pay?
Most companies will use a third-party algorithm to determine the exact amount you’ll have to pay. This is determined by several weighed factors, which include:
- The size of your deposit (in % of the total mortgage)
- The total loan amount
- Loan type. For example, is the property an investment vehicle or do you plan to live in it yourself?
- Your current employment status
If maths isn’t your strong point, don’t fret – there are plenty of handy LMI calculators out there that can do the headache-inducing calculations on your behalf to give you a rough estimate of how much you can expect to pay. You can either pay this one-off fee when you complete your purchase, or you can simply have it added to the overall loan amount. The charge will then be absorbed into your usual monthly mortgage payments.
Mortgage Protection Insurance
So now you know that LMI protects the lender, it’s time to find out how you can protect yourself as the borrower. Mortgage Protection Insurance, also known as consumer credit insurance (CCI) or home loan insurance, ensures you will not lose your home should you default on your payments due to circumstances that are beyond your control. Think unemployment or redundancy, for example. This type of product is also often bundled with life insurance, ensuring your mortgage is paid off in case of death. Mortgage protection insurance commonly protects you from the following unforeseen events (though read the small print of specific products!):
- Terminal illness or other health crisis
- Death
- Involuntary unemployment
Your insurance premium (monthly payment) depends on several factors, including whether it’s a single or joint policy, the total amount you have borrowed for your mortgage, your age, and your monthly mortgage payments. Whether it’s preferable to go for a specific mortgage insurance or a bundle with a life insurance option depends on your personal circumstances.
The fact that Lenders Mortgage Insurance is compulsory should be food for thought for you as the borrower. If the banks deem it prudent to protect their investment in this way, should it not stand to reason that individuals and families should take similar precautions? Most of us don’t think twice about insuring our cars or having contents insurance, but an alarming number of Australians do not protect what is perhaps their most important investment.