Lenders Mortgage Insurance (LMI) is an insurance policy which compensates lenders for losses due to the default of a mortgage loan.
LMI is commonly paid when the Loan to Value Ratio (LVR) is greater than 80%, it is worth noting that some lenders will have 'limited time' deals where LMI won't be paid on applications to 85% LVR.
Considering that LMI only covers the risk to the lender not the borrower, is it worth the premium?
Here is a point to consider should you choose not to pay the premium and instead save the difference.
On a property purchase of $500,000 with a deposit of only 10%, you would be borrowing at an LVR of 90% and as such would attract a mortgage insurance premium of approximately $9,000. This $9,000 premium could be capped onto your mortgage amount with most lenders, therefore, increasing your mortgage loan amount.
This also assumes that you have the required funds to cover the government, lender and legal fees that could be worth as much as another 5% of the property value.
Choosing not to pay the $9,000 LMI premium on your purchase of $500,000 would mean that you need to save a further $50,000 to go towards your deposit. If we remove external help to raise the funds (family and friends) you need to determine how long will it take?
Let’s say that you’re a couple on a good income and can save the extra $50,000 over a period of two years.
What does this mean for your $500,000 purchase?
Presuming that over the next two years while you're saving the extra $50,000 to avoid the LMI premium your dream home increases by an average of 6% per year. For example;
Buy now at $500,000
Charges $25,000 (Approx. 5% of house price)
Buy in 2 years at $561,800 (Assume 6% increase per annum)
Charges $28,090 (Approx. 5% of house price)
In two years your total cost has increased by $64,890 and now a 20% deposit is now $112,360, not $100,000 meaning over this 2-year period you needed to save a further $62,360 not $50,000.
On top of this, you are now required to pay additional charges of $3,090 more, using 5% of house price as a guide.
Let’s presume you get to this point and have managed to save the extra, but what is the cost?
You’re now paying $61,800 for the same house. You’re now also paying charges of $3,090 more for the same house.
If you had chosen to pay the $9,000 LMI premium that $61,800 worth of capital growth could have been yours!
The end result, in this case, is the customers should have taken up the option to pay LMI.
$9,000 is an estimate based on a 90% lend paying mortgage insurance through Genworth.