Lenders mortgage insurance, or LMI, is a weird, one-sided, and almost unfair costs of buying property. Especially for the new generation of property buyers. So what’s the goss on mortgage insurance. Well, let’s start at the top.
What is Lenders Mortgage Insurance?
To answer this question, we start up top to answer how does a bank work at a high level. A bank borrows money from the savers of the world, from other banks, the government, etc… to then lend it out to you the end home loan customer. When you borrow $500,000, the bank has borrowed $500,000 from other people to give it to you. A bank is a big pool of money, and when you are pooling money the most important fact is managing your risk.
And this is where lenders mortgage comes into it, it’s an insurance contract to manage the bank’s risk of losing money.
Who provides Lenders Mortgage Insurance?
There are only two insurance providers in Australia; QBE Insurance and Genworth and they work with a number of banks to provide the insurance over the property purchase. There are also a number of banks, that ‘self’ insurer’ and these banks have their own in house teams to manage the risk and add their own insurance.
So at what point do I pay Lenders Mortgage Insurance?
If you have ever heard people say, ‘Do you have a 20% deposit’ or make sure you get to a 20% deposit, it’s because of mortgage insurance. You start to have mortgage insurance added to your loan when your loan to value of the property is over 80%. So here are few examples for one house price of $500,000. We have assumed in this example there are no government grants, so you are paying the full amounts.
Have a look at this table and the comments below:
You can see that we have a house price in a row (A) all of $500,000 and underneath are all the costs to buy that style of property (in Victoria) which is; Stamp Duty, Land Transfer Fee, Mortgage Registration and then a buffer for any potential settlement and legal fees. From there Row (B) has a few scenarios on the deposit amount from $140,000 all the way to $67,000 which helps you calculate your Base Loan (D) and Base Loan to Value Ratio (E). You can see in the first two scenarios when the Base Loan to Value Ratio is under 80% the Mortgage Insurance in row (F) is 0 (yay!). That’s because, this is the key point, keeping that figure under 80% if your goal is to avoid paying mortgage insurance.
As your deposit lowers ($100,000 to $67,000) you can see Mortgage Insurance (F) increases from $5,454 to $13,271 as the bank assumes there is more risk, and it’s contributing more and more of the loan, so it gets nervous and adds the Lenders Mortgage Insurance contract.
To avoid mortgage insurance, the key point is having your Base Loan to Value at 80% (well technically 79.99999…..%)
How is Lenders Mortgage Insurance calculated?
Lending mortgage insurance is calculated based on a number of factors. Like when you go and get car insurance, and they ask you a lot of questions, the same thing can be said about mortgage insurance, they ask you a lot of question during a home loan, but there are two main factors:
1. The higher the loan to value ratio the greater the bank’s risk = more lenders mortgage insurance (table above)
2. The higher the loan the bigger the insurance risk = more the lender’s mortgage insurance (table below)
As you can see above, in row (E) my Base Loan to Value is 85% across all the house prices (A) from $500,000 to $1,300,000. You would think that because you are putting 15% down in each scenario plus costs the contract is the same, sadly no! The Ferrari car insurance costs way more than the Mazda CX-5. The same can be said for the above, because the loan increases from $425,000 to $1,105,000 the increase contract powers on up towards $18,354!
Well, should I pay mortgage insurance?
A great question. A lot of people have this stigma about mortgage insurance, it’s bad, it’s evil it’s blah. Well, it could be all of that, but if it allows you to get into your house earlier because of a lesser deposit, then it may be worthwhile. The Heroes team always says, if you buy a good property that lasts you ages, then things like the price you paid, the mortgage insurance, etc in year 20, 30 (maybe 40) become irrelevant.
How do I pay for my mortgage insurance?
One of the biggest misconceptions is that mortgage insurance has to be paid upfront! Wrong. You have the choice, you can choose to pay it in one lump sum or, it can be added to your loan and paid off over 30 years. Here is how much $20,000 of mortgage insurance would cost you per month, over a 30 years loan at 3% interest rate (in Oct 2020) = $85 per month. You can see why it’s not that scary, I can almost promise that if you buy a good house it will go up over time more than $85 a month!
Can I transfer my mortgage insurance?
Sadly no, it is not transferable. If you pay it once on a property then it can’t be transferred to another property and also if you pay it once with a Bank and then want to refinance, you will have to pay it again (this is where it’s evil). So our goals for people are:
1. If you have to pay mortgage insurance, make sure you are with a reputable bank.
2. Try and get your Base Loan to Value at 80% by; paying down the loan fast or buying well so the house price goes up.