Angela Dye explains the benefits and pitfalls of mortgage insurance.
You may have heard the term mortgage insurance and wondered what it is and how it fits into the loan process when you are borrowing to purchase property. You may also be of the understanding that, as many other insurance policies do, it will cover you in the event of a loss.
However, mortgage insurance works in a very different way, and it is important to understand what it actually means to you and the loan process.
What is lender's mortgage insurance (LMI)?
Lender's mortgage insurance is an insurance policy that safeguards the lender from monetary loss if the borrower can no longer afford to keep up their home loan repayments.
If a borrower goes into arrears with their loan and the bank acts to sell the property then the mortgage insurance will be called on if the outstanding loan amount will not be covered by the funds available from the sale of the property. The mortgage insurer would cover any loss for the lender and would then turn to the borrower to repay the shortfall. It is important to understand that mortgage insurance offers no cover for the borrower.
So why LMI?
With today’s property prices on the rise it can seem a daunting thought having to save up a 20% deposit to purchase your dream home, especially in Sydney, where 20% of a purchase price plus stamp duty can add up to well over 100,000. It would seem like it is impossible to get into your first property.
It can become a neverending process when you are saving for a deposit, as it takes a long time to save the deposit needed, and in many cases once you have saved enough the market has moved and you are still left short of your deposit amount.
This is where LMI can help with reducing the amount you will initially need to contribute to the purchase to enter the property market, and own your dream home sooner or start your investment journey.
How does LMI work?
All banks have their own policies regarding loans which are subject to LMI. It is generally used when you need to borrow more than 80% of the purchase price of the property or in loan terms, when the loan-to-value ratio (LVR) is higher than 80%.
Subject to your bank’s criteria, you can borrow up to 95% inclusive of LMI, of the purchase price, and in some cases you can even capitalise the premium to the loan.
There is, however, a fee for having a loan with lender’s mortgage insurance. The fee is calculated as a percentage using the loan amount and the LVR of the loan. It increases as the amount and the LVR increases. It is a one-off fee payable at the start of the loan contract.
It is important that you understand your scenario when it comes to borrowing for the purchase of your new property, whether it is your first home or if you are purchasing to invest. Working with a professional mortgage broker will help you to determine the best solution for your scenario regarding borrowing.
If you'd like to learn more, Ask Ang!