Lenders Mortgage Insurance (LMI)
Is Lenders Mortgage insurance a bad thing?
When you have less than a 20% deposit to purchase a property you may be required to pay Lenders Mortgage Insurance (LMI). Is LMI a bad thing? Not necessarily – I will explain more below.
LMI is an insurance that protects the bank if you were to default on your home loan repayments.
The cost of the LMI fee depends on how much you need to borrow. In example – it would be higher for a loan where you’re borrowing 95% of the purchase price compared to a loan where you’re borrowing only 90%
Do we consider having to pay LMI a bad thing? While no one likes to pay insurance – especially to a bank! LMI doesn’t have to be viewed as a bad thing. In contrary – it can be a handy way for investors to leverage their funding and for first home buyers to get into their home sooner.
Here are some positive aspects of LMI.
LMI will help you get the keys to your home quicker
Trying to save a 20% deposit for a property isn’t easy. It can take years to save and if the value of properties continue to increase you could find yourself chasing your tail.
With LMI – you could have as little as a 5% deposit saved. Yes – you will have to pay some LMI but in some instances it can be added on top of the loan rather than coming out of your savings.
In this situation – you can get the keys to your house sooner (especially if you’re a first home buyer) and might be able to benefit from some capital growth that the property experiences in the short to medium term.
LMI can help property investors grow their portfolio quicker
Just as LMI can help a first home buyer get into their house sooner, it can also assist property investors with growing their portfolio quicker.
Let’s take an example. Let’s say Andrew and Sarah have $120k and want to purchase an investment property in Noosa.
Option 1: Buy one property without LMI
The investment property Andrew and Sarah are looking at in Noosa is an apartment that costs $400k. If they would like to avoid paying the LMI fee they would need to contribute $80k towards the purchase (a 20% deposit) plus enough additional funds to cover off the purchase costs such as stamp duty and legal fees which normally account for another 5% of the purchase price (or in this instance – $20k). So in total – it will set them back a contribution of around $100k in order to purchase their Noosa investment in order to avoid paying LMI. That’s most of their $120k gone towards this property.
Option 2: Buy two properties and pay the LMI fee
However, if Andrew and Sarah decided to use a smaller deposit and pay LMI they could stretch their initial $120k deposit over two investment properties. Let’s assume they decided to buy two properties worth $400k each – an apartment in Noosa and a townhouse down the road in Peregian using a 10% deposit on each.
For each purchase – they need to contribute $40k towards the purchase (a 10% deposit) plus additional funds to cover purchase costs of $20k for each property (refer to the stamp duty and legal fees in option 1) which comes to the grand total of $60k per property that they would need to contribute.
With option 2 – Andrew and Sarah have purchased two investment properties with their $120k savings. Hopefully these properties grow in value, if they do then in a decades time the LMI fee that they initially paid (it’s a once of fee added on top of the loan) might be a small cost in comparison to the growth in value that the two properties have experienced over the 10 year period.
This example demonstrates how Andrew and Sarah have leveraged LMI to purchase multiple investments
Please note. This strategy isn’t going to work for every borrower and is highly dependent upon your individual tolerance to risk. If you’re more risk adverse, then the first option would be better suited – if you’re willing to take on more risk in an attempt to grow your property portfolio quickly then option 2 could be a good fit.
It is also important to mention that with the first option – if there’s a small dip in the properties value it shouldn’t cause the borrowers to end up owning a property that’s worth less than the loan securing it. On the flipside – the second option means you would only own 90% of the property’s value so you’re highly leveraged at the beginning. Therefore, the same dip in property prices could see them in the red. For that reason – leveraging LMI for investments should be looked at as a long-term investment strategy and one that comes with risks.
Having said all that – this is a very basic explanation of how LMI can be leveraged so please seek professional advice regarding your own particular situation.
In most cases, the LMI fee can be added on top if your mortgage
As described earlier, LMI doesn’t usually need to be paid for from your savings. A lot of banks add it on top of the mortgage – or “capitalise” it.
It could be deductible
The LMI fee that’s linked to an investment property mortgage is usually a deductible expense that can be claimed over a 5 year period. I’m not an accountant though! So please seek professional advice from a qualified accountant.
So there you have it – they are some general thoughts as to why I think that LMI isn’t the terrible fee that it’s made out to be. Feel free to drop me an email if you have any questions.
About the author: Jamie is the owner and founder of Pass Go Home Loans and operates between the Noosa and Canberra offices. If you’d like Jamie to provide you with some credit advice – just complete and return this FORM
This information is not intended to act as financial, investment, legal, accounting or taxation advice – and for that reason should not be relied upon as specific advice for your situation. You should always obtain independent, professional advice prior to making any financial, investment, legal or taxation decisions.