Lenders Mortgage Insurance – do you know what you’re paying for?
More Aussies are taking out home loans requiring them to spend thousands on Lenders Mortgage Insurance (LMI), but do they really know what they’re paying for?
A 2018 survey found more than half of first-time borrowers mistakenly think this insurance protects them, when in fact it protects the banks – sparking calls from consumer group CHOICE for it to be abolished.
Recently, however, a ground-breaking new product has hit the market which promises to take some of the sting out of LMI for mortgage holders.
What is Lenders Mortgage Insurance?
To qualify for a home loan, you typically need at least a 20% deposit plus costs, meaning you will only be allowed to borrow up to 80% of the value of the purchased property.
Some lenders do allow homebuyers to borrow with a deposit of less than 20%, but in this case they generally insist on you buying LMI.
What does LMI cover me for?
LMI does not cover you for anything: it protects your lender against the risk that you default on your loan repayments.
If you are unable to repay your outstanding loan amount, your LMI insurer will reimburse your lender and then ask you to repay any shortfall to them. If you don’t, they can sue you.
How much does LMI cost?
As a very rough guide, LMI can cost over $10,000 on a home loan of $500,000 for which you’ve saved a $50,000 deposit.
As the borrower, you have to pay for it even though you have no say in how much it costs. And you don’t get the option to shop around for a better deal, because you are forced to use the LMI chosen by your lender.
How do I pay for LMI?
LMI is the only insurance in Australia where all premiums must generally be paid up front in one lump sum, instead of in instalments.
You can pay your LMI in full when you loan is approved – but this is likely to prove quite difficult if you’re already so cash-strapped that you couldn’t afford a full deposit.
Or your LMI can be capitalised and repaid along with your loan – making repayments easier to shoulder, but far more expensive for you in the long run, as you’ll be paying interest on both your loan and your LMI.
LMI is big business, with APRA figures showing the share of new home loans with a loan-to-value ratio above 80% increased to over 22% in the June quarter.
But the Productivity Commission inquiry into Competition in the Australian Financial System (2018) was scathing about this form of insurance. It recommended government intervention in the LMI market to protect the interest of borrowers, saying:
LMI discourages home loan refinancing for a better home loan deal;
There is little incentive for competition on LMI prices, since the borrower pays for it but has no control over how much it costs (this is decided by the lenders and LMI providers);
LMI doesn’t achieve its goal of helping low-income earners get onto the property ladder: it drives up property prices, and most of the benefit goes to middle and high-income earners.
CHOICE CEO Alan Kirkland agreed, saying: “It’s an extremely opaque market … it’s very hard to justify the existence of LMI in its current form.’’
Can I get if an LMI refund if I pay my loan up early or refinance?
If you don’t ask, you’ll never know, so it’s certainly worth requesting a refund on your LMI.
However, insurers generally only offer refunds if you cancel the policy within one or two years, and then will sometimes only return as little as 20%. And some lenders won’t agree to process LMI refunds for any loan terminated before maturity.
Sometimes the hefty price of LMI discourages people who still owe more than 80 per cent of their original loan amount from refinancing for a better deal – the very people who would benefit most. There is now an alternative way to pay for LMI that could address this issue. See below ….
Who provides LMI?
There are two major LMI providers in Australia, Genworth and QBE, and some of the banks operate their own LMI subsidiaries or self-insure – for example Commonwealth Bank offers a one-off fee called a Low Deposit Premium that works like LMI.
LMI with monthly premiums
This month, Genworth has just released a new Australian-first LMI product that is paid in monthly instalments rather than in one lump sum up front. This means a greater portion of a home loan can be used to support the purchase of the property and makes it much easier for borrowers with LMI to refinance.
“To address the increasing demand for “entry level” first homes which are held for less than five years we recently announced a new monthly premium LMI offering,” said Genworth Mortgage Insurance CEO Georgette Nicholas.
Ms Nicholas said that borrowers “can pay the LMI premium in instalments over time, which means a greater portion of their loan can be utilised to support the purchase of their first home.
“Importantly, our new monthly premium LMI provides borrowers with the flexibility to refinance at a later date without the need for a refund of LMI premium,” said Georgette Nicholas.
Mortgage Protection Insurance
Many homeowners stress about being able to pay their mortgage if something goes wrong. LMI can’t help with that, but another form of insurance called Mortgage Protection Insurance (MPI) is designed for this purpose.
MPI can cover your mortgage repayments if you should suffer injury, accident, death or redundancy.
However before buying MPI, you should speak to a financial advisor or other expert to see if you may be better off relying on income protection insurance and/or life insurance, which can provide wider protection than MPI and may be more cost-effective too.
How to avoid paying for LMI
Save a 20% deposit
Buy a cheaper property
Arrange a guarantor (though some banks are cutting down on this)
Become a doctor! (lenders exempt some high-income people such as doctors and lawyers from LMI)
See if you qualify as one of the 10,000 borrowers who will be able to buy a home with just a 5% deposit and no LMI through the government’s First Home Loan Deposit Scheme, which starts in January 2020.
Shop around – rates for LMI vary widely between banks, so compare lenders to see who has the best deal for you.
The information contained on this web site is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser. If you or someone you know is in financial stress, contact the National Debt Helpline on 1800 007 007.