LMI protects your lender in the event that you default on your home loan and there is a ‘shortfall’. A shortfall happens when the proceeds from the sale of your home are not enough to cover the outstanding amount you owe to your lender.
Your lender may be able to recover the shortfall from the LMI provider – but even if they do, it doesn’t mean you’re off the hook. The LMI provider may seek to recover the shortfall amount from you.
If LMI is required, you’ll have to pay the insurance premium. But it’s important to remember that LMI doesn’t provide you with any protection even though you pay for it – it’s there for your lender’s protection.
When is LMI needed?
LMI may be required if your home loan deposit is less than 20% of your property’s 'lender-assessed value'. This is a value based on your lender’s valuation of the property you want to purchase. In other words, it’s based on the lender's assessment of the property's market value.
If your deposit is less than 20% of the lender-assessed value, it means you have a Loan to Value Ratio (LVR) of more than 80%. Borrowers with an LVR of more than 80% are usually required to pay for LMI. This is because an LVR of more than 80% is considered to be a higher risk to the lender.
Different lenders have different rules about when LMI is required. When you apply for a home loan, the lender will help you determine if LMI is required. They should also let you know what the approximate cost of the LMI will be.
How does LMI work in practice?
We’ll use an example to explain how it works.
- Let’s say you default on your home loan and there’s still $600,000 owing.
- Your lender then sells the property to recover this amount – but they only recover $550,000 when the property is sold.
- That means there’s a shortfall of at least $50,000.
In this case, your lender may claim the shortfall from the LMI provider. The LMI provider may seek to recover the $50,000 shortfall from you. In other words, LMI protects the lender – it doesn’t protect you at all.
Make sure you don’t confuse LMI with mortgage protection insurance – this is a completely different insurance product altogether. Mortgage protection insurance is designed to help you meet your mortgage repayments in the event that you become seriously ill or incapacitated and are unable to work.