If you’re a first home buyer looking to buy your first home or have already decided on one, you might come across many terms such as lenders mortgage insurance or mortgage protection insurance.
It can be overwhelming and confusing but fret not as Soho is here to help. We’ll be explaining Lenders Mortgage Insurance in this article as well as some things you might need to take note of to allow you to make a sound financial plan.
What is lenders mortgage insurance (LMI)?
Lenders mortgage insurance, also known as LMI is an insurance policy that protects the lender, essentially the one that is providing you with the mortgage amount. It’s typically a one-off payment made by a borrower (you) at the time of the loan.
This insurance protects the mortgage lender against any losses they may incur in the event that the borrower can no longer make loan repayments. When that happens, the lender would be able to recover what’s owed by repossessing the property to which the loan was tied to.
However, the value of properties fluctuates and LMI helps to protect the lender against any depreciation of the value of a property.
Conditions to pay LMI
You might be wondering whether everyone who borrows is required to pay LMI, and the answer is no. Lenders Mortgage Insurance is typically required for borrowers when the deposit for a loan is less than 20% of the property value.
This is usually the case because lenders perceive borrowers with deposits over 20% as someone who is less likely to default. A 20% deposit is also a large enough buffer to protect lenders from the depreciation of property over time should there be a failure to make repayments.
However, the value you need to deposit to avoid paying LMI might vary in areas and this is usually the case in areas where there is a high risk of a property prices falling. To avoid paying for LMI, the borrower might need to put down a bigger deposit which can be almost 30% of the property value.
Is there any way to avoid paying LMI?
There are, however, exceptions to paying for LMI in instances besides meeting the deposit of 20% of property value and these are:
- Shared equity agreements
- Having a guarantor
- Working in a highly-regarded profession
- Reduced Equity Fee/Low Deposit premium
Shared equity arrangements
Shared equity agreements are a financial arrangement that allows a third party (most commonly a family member) to contribute to the purchase cost, most of the time it would be to increase the deposit amount to above 20% of property value.
In exchange for contributing to purchase cost, the contributor receives a portion of the equity when the property is sold in the future.
Guarantors are people that legally accept responsibility for mortgage repayments if the borrower is unable to make them, in most cases, it would usually be parents. Hence this allows borrowers to have more security since the arrangement is legally binding for the guarantor to pay the remaining repayments
Working in a highly-regarded profession
People working in the following fields are considered low-risk due to the origin of the work being highly paid and relatively stable. Sometimes, they can even borrow up to 90% of the property value without having to pay for LMI.
- Doctors (GP, optometrists, dentists)
- Accountants (auditors, actuaries)
- Lawyers (solicitors, judges, barristers)
Reduced Equity Fee/Low Deposit Premium – Risk fee
You might come across “reduced equity fee” or “low deposit premium” when browsing around for home loans and this is referred to as a risk fee. Instead of relying on LMI, lenders may create their own alternative and allow borrowers to pay a one-off risk fee.
The advantage of a risk fee is that the amount payable is usually lesser than that of LMI. Another advantage is that insurance tax would not be charged since ‘risk fees’ are not counted as insurance covers.
These savings are generally passed on to the borrowers, which allows for lower rates than LMI. Do note that not all home loans provide a risk fee
Knowing all these, what’s the downside to LMI?
The downside to LMI would be:
- Longer approval period since the application will be going through 2 parties, lender company as well as the mortgage insurance company. Applicants will be required to pass the eligibility criteria for lenders followed by mortgage insurance.
- May end up paying more if you decide to absorb LMI premium into the loan instead of paying up front. The inclusion of LMI premium in your loan would cost you more with the premium accruing interest.
However, the advantage of LMI is to allow for the immediate purchase of the property. This is highly advantageous in areas where residential prices are constantly increasing. Buyers are able to own their homes sooner without feeling the pressure of saving up to achieve the 20% deposit standard.
LMI allows lenders to have the reassurance that lenders can pay off mortgage repayments and hence will allow for a successful home loan application. Hence, it’s very appealing for buyers with a lack of capital to start financing their homes
The most practical solution would be to pay a 20% deposit and avoid LMI completely since it will incur extra cost and take up more time in the long run. It is definitely important to save up a substantial amount of money to reach the minimum 20% deposit amount.
However, it still depends on individual circumstances at the end of the day, and hence, it is best to consult with an appropriate broker to discuss your options and do the right calculations.
It is also important to have a clean credit record as that is something that mortgage lenders look into as a factor in determining if you’re able to do mortgage repayments.
If you need help with home loans, you can get in touch with Soho Home Loans and speak to our home loan experts through a simple phone call.