What Is LMI and When Do You Have to Pay It?
LMI is one of those lending terms people hear all the time, but many are not fully sure what it actually means.
If you are buying a property with a smaller deposit, there is a good chance it may come up during the home loan process.
So what is it, when do you pay it and does it always have to be a bad thing?
What is LMI?
LMI stands for Lenders Mortgage Insurance.
It is an insurance premium that usually applies when a borrower has less than a 20 percent deposit. It protects the lender, not the borrower, in case the loan goes into default and the lender cannot recover the full debt through the sale of the property.
That is the part that often surprises people.
You pay for it, but it protects the lender.
When do you have to pay LMI?
In many cases, LMI applies when you are borrowing more than 80 percent of the property value.
This is known as having a loan to value ratio above 80 percent.
For example, if you are buying a property with a 10 percent deposit, there is a strong chance LMI may apply depending on the lender and the type of loan.
Some lenders have different policies and there are some situations where LMI may be reduced or avoided, but broadly speaking, a smaller deposit increases the likelihood of it being part of the costs.
Why does LMI exist?
From the lender’s point of view, a smaller deposit means higher risk.
If property values fall or the borrower cannot keep up with repayments, there is less of a buffer in the property.
LMI helps cover that extra risk for the lender.
That is why it tends to come into the conversation when buyers are trying to get into the market sooner with less saved.
How much does LMI cost?
There is no single set price.
The cost can vary depending on:
the property value
the size of the deposit
the loan amount
the lender
whether the loan is owner occupied or investment
The lower the deposit, the higher the LMI cost usually becomes.
That is why even a slightly larger deposit can sometimes make a meaningful difference.
Can LMI be added to the loan?
In many cases, yes.
Rather than paying it upfront, some lenders allow LMI to be capitalised into the loan amount.
That can make it easier from a cash flow point of view at the start, but it also means you may be borrowing more and paying interest on that amount over time.
So while it can help you move forward sooner, it still needs to be looked at properly in the wider picture.
Is paying LMI always a bad thing?
Not necessarily.
A lot of people hear the word insurance and immediately think it is just an extra cost to avoid at all costs.
Sometimes that is true. Sometimes it is not.
For some buyers, paying LMI may allow them to buy sooner rather than spending years trying to save a full 20 percent deposit while property prices continue to move.
In that situation, paying LMI may actually help them get into the market earlier and start building equity sooner.
So the question is not always “how do I avoid LMI at all costs?”
Sometimes the better question is “does paying LMI make sense in my situation?”
Can you avoid LMI?
Sometimes.
A few ways people may reduce or avoid LMI include:
saving a larger deposit
using a guarantor structure where appropriate
accessing certain first home buyer or professional lending options where available
choosing a lender with more favourable policy settings
This is where good advice can make a difference, because what is possible can vary quite a bit depending on your position and the lender being used.
The biggest mistake people make
The biggest mistake is looking at LMI as just a fee and not as part of the wider strategy.
Yes, it is a cost.
But the more important question is whether paying it helps you achieve something valuable sooner, or whether waiting and saving more is the smarter move.
That answer depends on your goals, your budget and what the numbers actually look like.
Final thought
LMI can feel frustrating when you first hear about it, especially because it is a cost paid by the borrower that protects the lender.
But it is not always something to fear.
In the right situation, it can be a tool that helps someone buy sooner and move forward earlier than they otherwise could.
The key is understanding what it means in your case and whether it makes sense as part of the bigger picture.
Need help understanding what LMI could mean for you?
If you are not sure whether LMI may apply or whether it makes sense in your situation, speak with The Mortgage People.
We can help you understand your options and what may make sense from here.