When buying or refinancing a home or investment property, if you’ve got less than 20% deposit you’ll be viewed by lenders as a high risk – so they use Lenders Mortgage Insurance to protect their position (they buy insurance).
Understanding how it works and how it differs from bank-to-bank, you could save yourself thousands.
Included within this article these Case Studies:
- Simple LMI Comparison for those buying or refinancing just 1 property (this could save you $4,000)
- The LVR Tweak (a simple hack that often saves +$2,000)
- Refinancing (avoid some pain)
- Using Your Equity (to purchase another home or investment)
What is Lenders Mortgage Insurance and how does it work?
Think about stuff that you insure…
Whether it’s your car or house or whatever. You insure against the risk of loss.
Lenders do the same thing with your mortgage, to protect themselves (not you) against loss, just in case you don’t pay back the loan and they end up losing money after foreclosing on you.
But you pay the insurance premium (not the lender).
It’s effectively a high risk fee – you become a higher risk to the lender when you have a smaller deposit.
It provides you with no protection whatsoever, it only provides protection for the bank. But it helps you buy a property sooner.
If your lender has to sell your house, they have a risk of loss. That risk being the possibility that the sale proceeds is less than the amount you owe. This is where the LMI helps out, it pays the bank to cover for their loss (but the LMI will probably come knocking on your door to look for their loss!).
How much does Lenders Mortgage Insurance cost?
It’s a one-time fee charged at initial drawdown of your loan.
The premium varies but is often very expensive but can vary from bank-to-bank a lot.
There’s a number of factors that cause your premium rate to increase.
Let’s explain the rate…
- LMI is charged at a percentage of the loan amount.
- That percentage rate that you’re charged is smaller when you borrow just above 80%, and it increases substantially as your loan percentage gets higher.
The formula for calculating your LMI fee is:
Loan Amount x Rate = LMI Premium
The rate is a percentage of the loan amount, is often different for every application, and depends on your:
- Loan Amount
- LVR (Loan Value Ratio)
LVR is the Loan Amount expressed as a percentage of the property value (eg. 95% means you’re borrowing 95% of the property value, with a 5% deposit).
Every lender has unique rates (and they can vary a LOT). Even when they use the same mortgage insurer, their rates can differ significantly.
Take a look below at this rate card from one of the major banks…
In the examples within the above image, you’ll notice two “variables” mentioned above (LVR and Loan amount) will influence which rate is used to calculate your LMI fee…
As your LVR (Loan-Value Ratio) increases, so does the rate at which your LMI fee is calculated.
The second variable being the loan amount. As your loan increases, it also forces the rate at which your LMI fee is calculated to increase.
If you’re increasing both loan amount and loan ratio, it’s a double-whammy!
Using the example in the above green boxes, within the image…
- A $375,000 loan with a LVR of 85%, has a LMI fee of $3683 (plus about 10% stamp duty, taking total fee to around $4000).
- Compare that to a $375,000 with a LVR of 95%, and the LMI is $12,000 (plus stamp duty, taking the total LMI to $13,200).
- The two loan amounts are the same, but the increase in loan ratio triples the fee.
What happens when your borrow (add) the LMI fee on top of your Home Loan…
This section is really going to dig in to the details.
It’s easier to quickly understand on video, so watch the video below to get the best possible explanation. Below the video we also explain in text if you’d prefer to read.
There’s a few concepts for you to understand…
Concept #1) Lenders Mortgage Insurance is usually capitalised
- That means, you borrow the LMI fee and it’s added to your loan amount.
- Therefore, LMI fee will increase both your loan and your LVR (loan ratio).
Concept #2) Loans that have LMI added will have a “Base LVR”
- The Base LVR is the loan ratio, calculated before the LMI fee is added to the loan amount.
Concept #3) Your LMI fee is calculated off the Base LVR rate
- Use the LMI rate applicable to the LVR and the loan amount before the LMI is added.
- Don’t use the rate applicable to the final loan amount.
Concept #4) Loans with LMI added will have an “Effective LVR”
- The Effective LVR is the loan ratio, calculated after the LMI fee is added to the loan amount.
Concept #5) Lenders will have both a maximum Base LVR and a maximum Effective LVR
- Your loan amount before the LMI is added can’t exceed the maximum Base LVR.
- Your loan amount after the LMI is added can’t exceed the maximum Effective LVR.
Concept #6) Many lenders have the same LVR for the maximum Base LVR and the maximum Effective LVR!
- For example, it’s common for lenders to have a maximum Base LVR of 95%, but their maximum effective LVR is also 95%.
- This means, we have to manually adjust the Base Loan Amount, so that the Base LVR reduces (hypothetically, reducing it to 92.55%) and then there’s enough room to add the LMI fee to the loan and keep the loan amount below the maximum Effective LVR limit of 95%….
Clear as mud? Watch the above video for a simple explanation and demonstration.
What’s the maximum Loan-Value-Ratio when borrowing with Lenders Mortgage Insurance?
Depending on your lender policy (the two LVR’s below vary a lot from bank-to-bank, but these are the maximum)…
- Currently the highest Base LVR (loan ratio) is 95%.
- The premium may be added to the base loan amount (but when adding the premium to a 95% base loan you will have very few lenders to choose from and the rates will be higher).
- It’s best to stick to a maximum loan of 95% after the premium is added to your loan – if you want low rates and fees.
So, you’ll need at least 5% deposit, plus other purchase costs (eg. stamp duty, transfer registration, etc).
How can I avoid Lenders Mortgage Insurance completely?
Generally, you need 20% equity (cash or equity from another property).
Some lenders have Professional Packages for Doctors, Accountants, and other professions where you can borrow up to 90% without incurring LMI.
A 20% deposit leaves the lender some wriggle-room if you default in the future.
By having a decent amount of equity, should your lender be forced to sell your property there’s a good chance they won’t lose any money. So this is a risk they’re comfortable taking.
Case Study 1: A Simple Comparison that could save $4,000
What you don’t find in any advertised material online, is the variations to Lenders Mortgage Insurance fees.
In these examples, you’ll notice the Big 4 do quite poorly (which is not always the case) so you’ll want to get a broker to compare your exact scenario for you.
Purchase Price $630,000 with a Loan of $567,000 (at a 90% Loan Ratio)
- Lowest Quote = $10,816
- Best of the Big 4 = $13,476
Purchase Price $600,000 with a Loan of $570,000 (at a 95% Loan Ratio)
- Lowest Quote = $19,509
- Best of the Big 4 = $23,609
Case Study 2: The LVR Tweak that could save you +$8,000
I see this case study all the time… Where a minor adjustment to the Loan Ratio (LVR) creates a massive saving in the cost of the Lenders Mortgage Insurance fee.
Not everyone that you talk to about your home loan will do this for you, so take note…
In fact, earlier this year I took the extraordinary step of helping a competitor improve their quote to a client we were looking to engage. I had to explain to the bank manager exactly this…
Reduce the loan amount by $100, the LVR will reduce below the tier. And then you’ll save about $2,000 off the LMI fee.
Of course the bank manager was a bit awkward in discussing this issue, but promptly adjusted the loan details. The client was even happier, that I helped her get the best quote possible from her existing bank (so we compared apples with apples) and then I was still able to get her a better deal.
So let’s take a look at how the LVR Tweak actually works…
A couple of things to point out about the below example:
- Borrowing more than 90% LVR (loan ratio) by just $1 causes a big jump in LMI fee
- Borrowing over $500,000 by just $1 also causes a big increase in the LMI fee
We achieved over $8,000 reduction in LMI fee, just by reducing the LVR to 90% and the loan amount to slightly below $500,000.
Please note: The Loan Amount & LVR tiers are different from bank-to-bank
Case Study 3: Refinancing? Avoid paying LMI twice!
If you paid Lenders Mortgage Insurance on your existing loans, it’s probably not a good idea to pay it again.
Make sure you get a thorough product comparison that compares your existing loan Vs the new loan and can see exactly how long the savings will recoup any upfront cost of refinancing.
If you’re quoted on “comparison rates” please remember that a comparison rate won’t include LMI fees in the quote…. Comparison rates are an annual average percentage rate, taking in to account loan fees, intro-rate periods, etc. The LMI fee is charged by an insurance company so it doesn’t come in to play with a comparison rate.
When increasing your loan with the same lender, you’ll only pay the difference between the original fee and what the total fee should be now.
There used to be refunds when closing your loan in the first year or two, but these are not common now.
In the video below, you’ll see exactly how the LMI fee is calculated when you increase your loan with your lender (you get no discount on your LMI fee if you change lenders, even if your new lender uses the same Insurance company).
Case Study 4: A Little Trick to Reduce Your Lenders Mortgage Insurance by $10,207
Remember the 2 variables that effect the Lenders Mortgage Insurance cost?
- Loan Amount
- Loan to Value Ratio (LVR)
The premiums are calculated based on the total loans and the loan ratio. And because LMI is a product offered by an Insurance company, they’re all about…. RISK.
And ultimately, the risk is directly tied back to the SECURITY being offered.
Unfortunately, I’ve lost count on how many times I’ve seen a simple lack of the right structure and advice, cost people like you a lot of money.
By the way, if you’re adding $3-5,000 to the cost of your loan on day 1 it’s definitely going to cost you a LOT more over the term of your loan (think about it, that last $3-5,000 of your loan when you finally pay it off has been there the whole time, accumulating interest year after year after year….).
Using the same LMI rate card above, let’s dissect an example of how structuring your loans the right way makes a difference.
James and Jenny Johnson have been living in their home for a few years, and it’s been valued at $520,000 with a debt of $380,000. They’ve got their second baby on the way, so want to purchase a bigger home, and have found one they like for $670,000. They’ve got some money in their offset account to pay for stamp duty, but they’d like to borrow $670,000 by leveraging their existing equity. They intend to rent out their current home as they don’t want to sell.
So, James and Jenny would normally be offered a new loan, that directly leverages their equity.
- Existing Property Value = $520,000
- New Property Value = $670,000
- Existing Loan = $380,000
- New Loan = $670,000
- Total Debt = $1,190,000
- Loan to Value Ratio = 88.24%
- Rate at which LMI is charged = 2.49% (this varies bank-to-bank)
Take a look at this image, and notice that both properties are linked to all loans…
- The outcome is an LMI fee of $28,759
Here’s the Hack:
Because the Lenders Mortgage Insurer calculates their premium rates, based on the total loans and total securities, all you have to do is separate the properties and the loans.
Here’s how that would look… (notice the wall between the loans and the properties?)
- The outcome is a saving of $10,207 just by separating the securities.
- The LMI fee is reduced from $28,759 to $18,552
- See the wall above, separating the properties and the loans?
- Notice how you still accessed the same amount of leverage from the existing property? You just had to do it in a small stand-alone loan rather than bundle it in together with the rest of the new debt.
Here’s a snippet of the rate card used, so you can see how we worked out the above numbers:
when calculating LMI rates using this card, we added 10% for stamp duty (varies State-by-State).