Purchasing a home is a major life milestone for most people – but for many buyers, the biggest hurdle is saving the initial deposit required. The standard deposit is typically 20% but if you haven’t reached this mark, you might still be able to buy sooner thanks to something called Lenders Mortgage Insurance (LMI). A common misconception is that LMI protects the borrower. In reality, it protects the lender. Let’s break down how it works, why it’s used and what it means for you as a borrower.
How does LMI help home buyers?
Most lenders require the standard minimum deposit to be at least 20% of the value of the property. If you don’t have this amount saved up, it can be hard to qualify for a loan. Lenders Mortgage Insurance (LMI) helps to make it possible for buyers that don’t have a 20% deposit to access finance. It’s a one-off payment that insures the lender in the event that you default on your loan and if the proceeds from the sale of the property are insufficient to pay the loan off in full. This means that instead of requiring the usual 20% deposit, borrowers can purchase a house with as little as 5% deposit by using LMI.
How is the LMI premium paid?
LMI is a one-off premium paid by the lender at the time your loan is settled. The cost depends on:
• The size of your deposit (or Loan-to-Value Ratio, LVR)
• The amount you’re borrowing
• The lender’s policy
The lender will pass on the cost of this premium to you. In most cases, you can either:
• Pay it upfront at settlement, or
• Capitalise it onto your loan (add it to your loan balance, so you repay it over the term of your mortgage).
It’s important to note that capitalising the premium means you’ll pay more interest on your loan over time, so it is worth considering the long-term cost over the life of the loan.
What happens if you can’t repay your loan?
If you fall behind on repayments and no solution is found, your property may need to be sold. Sometimes the sale price is less than the remaining loan balance, leaving a shortfall. Here’s what happens:
1. You remain legally responsible for repaying that shortfall.
2. The lender makes a claim on the LMI policy to cover their loss.
3. The LMI insurer pays the lender.
4. The LMI insurer can then seek repayment of the shortfall directly from you.
How this looks in practice
Sarah borrowed $500,000 with a 10% deposit. Because her deposit was less than 20%, her lender required LMI, and she paid the cost of the premium. A few years later, Sarah was unable to make repayments, and the property was sold for $460,000. The outstanding loan balance was $480,000, leaving a shortfall of $20,000. The lender made a claim on the LMI policy and the insurer covered the $20,000 loss to the lender. However, the insurer can now ask Sarah to repay that $20,000 directly to them.This example highlights why LMI doesn’t eliminate your financial responsibility – it simply shifts the risk from the lender to the insurer. Who then can recoup any potential loss from you in the event things do not work out.
Financial hardship
If you’re ever in financial hardship, such as losing your job or being unable to work, it’s important to know that LMI insurers have hardship policies. These may include repayment plans, deferrals, or other options to help you manage your situation. If you find yourself in difficulty, reach out early – either to your lender or directly to the LMI insurer.
How LMI could help
A young couple have saved $50k, which gave them a 10% deposit on a $550k home. They borrowed the 90% ($500k) and paid $10k in LMI, which was capitalised onto their loan. This allowed them to buy a home now versus waiting a few years to have the standard 20% deposit saved up.
Over the next few years, the property value appreciated to $580k and even though they hadn’t paid down much of the principal loan balance. The growth in their property equity covered the original $10k cost of LMI which had been added to their loan. This example shows how LMI can be a useful tool for buyers who are financially stable but don’t yet have a full 20% deposit, or access to a First Home-Buyer Scheme.
Final thoughts
Whilst LMI adds to the upfront cost of buying a home, it can be a powerful tool for being able to purchase a property sooner. Understanding how it works – and what it doesn’t cover – helps you make informed decisions and plan your purchase with confidence. If you are planning to purchase a property and are unsure if LMI will apply to your situation, speak with a broker who can guide you through your options and help you compare costs.