LMI: Friend or Foe

Minimising costs is great, we should all do it. Sometimes however in saving as much as possible, we spite our long term potential by focussing too much on the short benefits. LMI is no exception – it can be both a tool and an unnecessary cost, dependent on the situation and how you utilise it with your lending.

What is LMI?

Lenders Mortgage Insurance (LMI) is a fee charged by lenders for loans which have <20% deposit or equity at purchase or refinance. LMI protects the lenders in the unfortunate event of the borrower defaulting on their home loan – which is at a higher risk when a lower deposit is used. Keep in mind that LMI is not to protect you, but the lender’s interests – you are still liable for any outstanding debts and repayments.

LMI is paid at settlement with all other lender and government charges, it can either be paid in cash with the contribution funds, or added to the loan (referred to capitalisation or ‘capping’).

How does a LMI loan differ from an uninsured loan?

80% LVR:

*No LMI charges paid
*Generally easier to finance – this can mean quicker turnaround times, flexibility with lenders policies (if a property is partially damaged, the insurer may not allow the purchase, but without LMI it would be possible), potentially no valuations required

LMI (80.01%-99% LVR)

*LMI applicable – a one off fee charged on the loan at establishment, generally can be added to the loan so long as the LVR’s are maintained
*Dependent on the lender and Loan to value ratio (LVR), the mortgage insurer (QBE, Genworth etc) may need to approve your loan as well as the lender – meaning you can potentially be declined on a loan that the lender is happy to offer
*LMI rates are scaled – the higher the LVR, the higher the rate of LMI is charged, likewise the higher the loan value, the higher the charge. As such a high LVR loan with a large loan amount can result in an extremely large LMI charge.

Which is best for me?

This really depends on the specific scenario of each borrower. The primary consideration is in weighing up the cost of the charge, versus the opportunity cost of adding additional funds into a purchase. If a borrower has substantial enough equity base where they can make their planned long term purchases with 20% deposits, then it may be an unnecessary cost.

However, if like most investors, the borrower is reliant on future savings and equity to continue to grow their portfolio, waiting for a 20% deposit before each purchase will significantly extend the time required for each purchase, pushing out the investment horizon for each investment and the eventual investment goals. In these cases it can be useful to utilise LMI as a tool to shorten the time between each purchase, gaining more exposure into the market sooner.

Useful tips to make the most of LMI

There are a few little useful tips which can help you minimise your LMI costs through using specific LVR’s and by careful forward planning to ensure you do not pay any excessive charges from unnecessary refinances.

The Sweet Spot

As previously mentioned, LMI is calculated as a multiplier against both the loan value and the loan LVR. As the LVR and loan amount increases, the multiplier increases exponentially. There is a point where you can minimise your deposit amount, but before the LMI charge rate rapidly increases – which is at 88% LVR (and allowing capitalising of the LMI, up to a maximum LVR of 90%). By keeping to this level, you can reduce your deposit requirements to 12%. Here’s an example of the subtle differences which cause significant savings:

Scenario 1 – 88% LVR + LMI

Purchase Price: $500,000

Loan Amount: $440,000

LVR: 88%

LMI Charge: $5,755

Scenario 2 – 90% LVR + LMI

Purchase Price: $500,000

Loan Amount: $450,000

LVR: 90%

LMI Charge: $9,911

In this one scenario, if the purchaser increased their deposit by 2%, it would result in a saving of $4,156, or 41% saving on the increased deposit amount.

Increasing Accessible Equity

By utilising LMI within reason as above, you can also tap into your existing properties to dramatically increase the deposit funds available for expanding your portfolio. Any LMI paid at purchase isn’t dead money, as it can then be used as a credit towards equity releases – meaning you can potentially release equity up to 90% with little or no LMI charged.

Likewise it’s possible to continually release equity at a declining LVR, to have each new LMI amount match the previous amount paid – effectively charging $0 LMI for each top-up, as you continually reduce your effective LVR until reaching 80%.

Exemptions

As of late there have been a small handful of lenders offering 85% LVR with no LMI as a promotion, this has been a temporary offer which has been a marginal saving for a lot of customers – however it cannot be relied upon to be offered indefinitely.

Likewise a number of lenders allow customers within certain industries which meet set criteria (income levels, industry membership) access to lending up to 90% LVR with no LMI charge. Industry professions can include lawyers, accountants, engineers, doctors etc.

Conclusions

Both a cost and a tool, LMI is an important consideration for all people looking to purchase property. LMI can be useful if used correctly and in a measured way. By strategically using specific LVR’s you can contain costs and open up options to rapidly grow your portfolio – compared to sitting out of the market saving more funds/waiting for equity growth.