If you are planning to buy a piece of real estate around Whittlesea or any other part of Australia, you need to put down a deposit large enough to avoid paying Lenders Mortgage Insurance, or LMI. The threshold is 20% of the property’s cost. If you spend a deposit worth less than this number, then you are required to pay an LMI premium.
This type of insurance protects not you, but your lender. In case of default, the LMI provider pays the lender to avoid any financial loss, which can be as little as $300,000 to over a million. As a borrower, it serves you no practical benefit. To make matters worse, it is you who pays for it.
Why is even LMI allowed then? Well, it is not as evil or unjust as you might think.
LMI Makes Home Ownership a Likelier Possibility
Back in the day, Australian mortgage lenders refused to loan money worth over 80% of a property’s price. Any amount higher than 80% was considered too risky, which still is today.
Although it is understandable why Australian lenders were allergic to mortgage applicants who could not afford to pay 20% of the property’s cost up front, it did not help make home ownership affordable.
In 1965, things changed. The introduction of LMI allowed more individuals, especially first home buyers, to borrow over 80% of the property’s appraised value in exchange for paying a fee. Since then, mortgage lenders have become less reluctant to loan outside of their comfort zone, and borrowers have enjoyed the privilege of not having to wait a lengthy period to save for a 20% deposit.
LMI Can Be More Bearable in the Future
In Australia, an LMI premium is charged as a lump sum payment up front. In other words, it can quickly eat into the money that a person borrows.
LMI rates vary from lender to lender, but they can represent as low as 0.475% of the loanable amount and as high as 4.603%. As a general rule, the more money you borrow, the higher the LMI premium you have to pay. If you can’t submit more documents to prove your creditworthiness to a lender, you need to contend with a rate higher than usual.
In the United States, Private Mortgage Insurance, the American counterpart of LMI, can be charged monthly until the borrower’s principal goes below 80%. No upfront charge and more incentive to pay down the mortgage are some of the benefits of this arrangement.
Right now, you can’t pay LMI on installment. Instead, you can capitalize it. LMI capitalization turns the one-off premium into an addition to the overall principal balance. In consequence, you do not have to pay for it, but your monthly mortgage payments, and so is the total interest, will increase.
LMI Is Not an Unavoidable Requirement
Fortunately, paying a 20% deposit is not the only way to avoid LMI altogether. Finding a guarantor is an effective way to reduce the risk your lender has to take to loan you the money. If you are a high-income earner, you can use your career to your advantage, for some lenders are willing to waive the LMI for medical practitioners or at least lax the requirement for other esteemed professionals.
LMI should be seen as a glass half-full. Yes, it can set you back thousands of dollars, but it delays your entry into the property market. If you decide to keep saving a deposit worth 20% of your chosen house, increased land appreciation is the opportunity cost you have to pay.