As Australia’s insatiable appetite for property continues to push house prices to record levels, more and more buyers (especially first home buyers) are finding that their precious and substantial deposit is simply not enough. With house prices increasing faster than many can save, it can seem like an impossible task to find that 20% deposit that most lenders require. Part of the solution? Lenders Mortgage Insurance.
So what is Lenders Mortgage Insurance?
If you take out a mortgage that is more than 80% of the value of the home that you are buying, then there is a good chance that your lender or bank will need to pay for Lenders Mortgage Insurance (LMI). This insurance is to protect the lender just in case the mortgage ‘goes bad’, i.e. you find yourself unable to pay the mortgage and default on the repayments.
Sometimes you hear people say 'the bank stills owns it' when referring to their home. This is because the house is the asset against which banks and mortgage providers secure their loans. Basically, if you stop paying, then they may move to force you to sell the home. If the resulting house sale price happens to be less than the outstanding loan amount, then the insurance will cover this shortfall.
Insurance is for the Lender, not you!
It is important to note that LMI insurance does not cover the homeowner. Indeed, the requirement for LMI often means that you have been deemed a ‘higher risk’ borrower. In this case, LMI is used to ensure the safety and security of lenders and banks. You will never see a bill for this insurance, as it is paid by the lender, but in reality, you pay for this through higher mortgage repayments.
How Lenders Mortgage Insurance helps the Homebuyer
Whilst Lenders Mortgage Insurance was created to offer greater security to lenders, it also allows those without a significant deposit to borrow up to 95% of the property value. Without LMI, these homebuyers may never have had the opportunity to buy that first home, and could find themselves essentially excluded from the market.
Also, to save a suitable deposit of 20% can take years of savings (during which time house prices historically have increased) meaning that for some it felt like they were spinning their financial wheels, and would sometimes resort to taking out two loans! Yes. Before the introduction of LMI, home buyers with an inadequate deposit would have to take out two loans. The first loan would be for the first 80% value of the home (the mortgage) and then the second loan would be given as a loan for the deposit. This was a very expensive means of getting on the property market. Furthermore, servicing two loans added a lot of stress to many first home buyers
It all boils down to risk. As Property prices increase faster than wage growth, so does the risk of default. So whilst Lenders Mortgage Insurance does not protect you, it does allow lenders to feel more confident to lend in the first place. It could be the difference between securing that home or missing out altogether.
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