by John McGrath

One of the challenges for buyers in a rising market is that property values are likely to increase faster than their ability to save for a deposit.  In many situations, Lenders Mortgage Insurance (LMI) can be the answer.

Say you want to buy a $400,000 apartment in a rising market where values are appreciating 10% per year – which is about what we are expecting for Sydney this year.

To avoid LMI, you need an 80% loan-to-value ratio (LVR) and hence a 20% deposit – or $80,000.

Say you saved that in two years.  Problem is, over this time the property would have grown in value to $440,000 in year one and $484,000 in year two.  So then you’d need a $96,800 deposit to reach 80% LVR.

In short, you’d be wasting a lot of time.

I asked Alan Hemmings, General Manager of McGrath’s mortgage broking division, Oxygen Home Loans, to get a quote on a 95% LVR loan for $400,000.  A big four bank offered $14,344 and a regional bank quoted $15,260.

So you could pay LMI of $14,344 and purchase now, in exchange for which you could make $84,000 in new equity via capital gains. Look at the numbers. You’ve recovered your LMI almost six times over in two years. 

You know the old saying, ‘you’ve got to invest money, to make money’?  Think of LMI as an investment.  It buys you precious time and gets you invested sooner. As always, do not borrow beyond your means, but if the numbers stack up then LMI is worthy of consideration.

According to Alan, borrowers have a better understanding of LMI these days and it is no longer seen as something to avoid at all costs.  Alan says: “Clients understand it can be expensive but they also understand it might be the only opportunity for them to secure the house of their dreams without the need to continue to save for a larger deposit.”

Alan’s the expert so I thought it was best for him to answer the most common questions I hear about LMI…

Q: What are the pros and cons?

A: Pros:

  1. You can buy sooner without a 20% deposit
  2. Investors can preserve their savings and maximise negative gearing benefits
  3. LMI can be ‘capitalised’ or rolled into the loan, so you don’t have to pay a lump sum upfront
  4. On investment properties, LMI can be tax deductible (make sure to consult your accountant/tax adviser)

Cons:

  1. The cost can be high, especially if you are buying a family home (LMI is partly based on the property’s value)
  2. If the property has little capital growth, your equity would build at a slower rate, which could impact future refinancing or your ability to buy your next property.


Q: What are the most common misconceptions about LMI?

A: That the insurance covers the borrower. The insurance covers the lender for the portion of the loan that is required above 80% of the purchase price. Another misconception is that the premium is transferable. If you want to refinance, you will have to pay a new premium and attempt to obtain a refund on the old premium.

Q: How is LMI calculated?

A: It is based on the amount the customer is borrowing compared to the purchase price of the property (how much deposit is being paid) as well as the actual amount of the loan (the higher the loan amount and the smaller the deposit, the higher the cost of LMI). GST and stamp duty is also charged on the premium.

Q: Why do LMI fees between banks vary?

A: The major reason is the lenders use different LMI providers or self-insure. Each lender negotiates their rates with the LMI providers and the risk profile of each lenders’ overall loan portfolio is a factor. Some lenders also don’t pay stamp duty for their LMI premiums, so they can pass that saving on to the client. It’s important to shop around or speak to your broker as the difference between lenders can be significant. For example, we compared the LMI on a 95% LVR loan for $600,000 and found a $7,390 difference between a big four and regional lender.  

Case study

Oxygen recently helped a couple with their first child on the way, who wanted to buy a family home. We discussed two options – LMI and a family pledge/parent guarantee arrangement where security would be taken against their parents’ property to reduce the LVR to 80%.

Two big four banks quoted LMI premiums of $20,350 and $20,900 and smaller lenders quoted $18,800 and $19,200. In the end, they chose a 90% LVR loan with the LMI capitalised into the loan. They wanted to stand on their own two feet; plus capitalising the LMI meant only a minimal weekly cost over the term of the loan.

People are very savvy about real estate these days but you’re never going to know more than a professional – especially in the financial services field where every bank has different criteria that is not necessarily shared with the public. Best option is to see a broker. If you’d like to talk to an expert at Oxygen, give them a call on 1300 855 699.