14/03/2023
LMI can be a foreign concept to First Home Buyers or anybody looking to buy property.
To put it simply, Lenders Mortgage Insurance (LMI) is a type of insurance that is often required by lenders in Australia when a borrower is taking out a mortgage with a high Loan-to-Value Ratio (LVR).
How does Lenders Mortgage Insurance work?
LMI is typically required by lenders when a borrower is taking out a mortgage with an LVR of 80% or higher. This means that the borrower is borrowing more than 80% of the value of the property they are purchasing. According to the lenders, this insurance provides protection to them in the event that the borrower defaults on the loan and the sale of the property is not enough to cover the outstanding debt.
How much does LMI cost?
The cost of LMI can vary depending on a number of factors, including the size of the loan, the LVR, and the lender's specific LMI premium rates. If we take an example property of $500,000, here are some estimates on what the LMI would cost.
A LVR of 90% is approximately 2% of the property value, meaning the LMI would be around $10,000
A LVR of 95% is approximately 4% of the property value, meaning the LMI would be around $20,000
Due to increasing property prices, the RBA has reported that loans with LMI have increased by 10% over the last decade. More people are aware of the importance of getting into the market and buying a property rather than waiting to save.
As you may know, to avoid LMI, you would usually need a deposit of 20%, which leaves you with a decision to make. You need to decide whether it is better to wait and save for a 20% deposit and battle with potential rises in property prices, or buy a property now and start generating equity but have to pay the LMI.
Let's look at an example to demonstrate why this upward trend of paying LMI is occurring.
Over the last 50 years, the Australian property market has on average increased by 6% per year and on average, it takes a family 7 years to save a 20% deposit.
If you are buying a property with $500,000, you would need to save a deposit of $100,000 to avoid paying LMI.
For this example, let's assume that it takes only 5 years to save the deposit of $100,000.
Assuming the property market increases like it has over the past 50 years, after the first year of saving that same property is now worth $530,000.
After the second year the property is worth $561,800
After the third year the property is worth $595,508
After the fourth year the property is worth $631,239
And finally, in the final year it takes to save the deposit, that same property is now worth $669,113
You have finally saved the $100,000
However that property is now worth $669,113 and now you need a deposit of $133,000 to avoid LMI
Meaning another year or two of saving
And another year or two of that same property increasing in price
If you were to buy that same property at $500,000 with a 5% deposit and LMI
You would need a deposit of approximately $45,000
However, in that 5 years that it has taken someone to save the 20% deposit, you have already generated $169,113 in equity
This is why so many more people are looking to buy property even if they are paying LMI
Of course, this is just an example and the property market doesn't grow at 6% every year. Instead it has years where it decreases, years where it increases and years where it stays the same.
While saving for a 20% deposit can take time, it can save you a significant amount in LMI fees and reduce your monthly repayments. However, buying now and paying LMI could allow you to enter the property market sooner and take advantage of potential property price increases.
The decision you face ultimately comes down to your personal circumstances, financial goals, and the current property market.
