Lenders Mortgage Insurance explained…

If you’ve ever had to pay Lenders Mortgage Insurance, it probably felt quite similar to being punched in the face.

If you don’t know what that feels like… It hurts.  No-deal!

However, unlike being punched in the face, Lenders Mortgage Insurance (LMI) is sometimes necessary.

And if you understand how LMI works, and how it differs from bank-to-bank, you could literally 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?

It’s simple.

Think about stuff that you insure…  Whether it’s your car or house or whatever. You insure that stuff against the risk of loss.

Right?

Lenders do the same thing with your mortgage.  That’s why it’s called Lenders Mortgage Insurance (LMI).

The reason your mortgage is insured, is to protect your lender against loss, just in case you default (don’t pay back the loan).

  • The catch is, you pay the insurance premium.

So, you’re paying the LMI fee so that you can purchase a property with a smaller deposit.

LMI 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 varies, but it does cost a LOT.

And remember this… It varies from bank-to-bank a LOT!

There’s a number of factors that cause your Lenders Mortgage Insurance rate to increase.

But first, let’s explain the rate…  That is, how the Lenders Mortgage Insurance is charged.

  • LMI is charged at a percentage of the loan amount (with some State government stamp duty added on top).
  • 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.
  • It’s a one-time fee charged at initial drawdown of your loan.

The formula for calculating your LMI fee is:
Loan Amount x Rate = LMI Premium*

* Once you have the LMI premium, you also have to add a some stamp duty (varies from State-to-State but is usually around 10% of the premium).

The rate is a percentage of the loan amount, is often different for every application, and depends on your:

  • Loan Amount
  • LVR (Loan to 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-to-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-to-Value Ratio (LVR) 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 highest Effective LVR is 99.9%.

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).

If you have a 20% deposit*, your lender is usually happy to waive the need for LMI and take the risk themselves.

A 20% deposit leaves the lender some wriggle-room if you default in the future.  Because you’ll have a decent amount of equity, should your lender have to sell your property there’s a good chance they won’t lose any money.  So this is a risk they’re comfortable taking.

But if you don’t have a 20% deposit your lender will probably insist on insuring the loan (because there’s a greater chance of loss if you don’t repay the loan).

* At time of writing, it’s possible to get LMI waived in very specific circumstances for a select few professions.  Additionally, it’s possible to borrow up to 85% with a couple of lenders, therefore requiring just a 15% deposit.

Case Study 1)  The Simple LMI Fee Comparison that could save you $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.

Example 1:  
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

Example 2:  

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… Remember, LMI is non-refundable!

You need to be reminded, because it’s possible (very likely, perhaps) that when you go to refinance your loan, the new Bank or Broker won’t ask you “did you pay an Lenders Mortgage Insurance fee on your existing loans”.

If the new loan comparison, includes the new LMI fee then that’s probably OK to refinance when the new loan is still cheaper over the long term, but make sure your loan comparison is done correctly.

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.

If you’re increasing your loan, you’ll only pay LMI on the new funds (provided you paid LMI on the existing debt), but when you change lenders completely, you have to start again, and pay LMI on the whole debt.

And you get no refund on the old LMI fee.

There used to be refunds (I personally even got a 40% refund when I sold a property less than 2 years after purchasing it – but that was back in about 2004).

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….).

Example:

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).

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