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.
How much does LMI cost?
As a very rough guide, LMI could cost over $10,000 on a home loan of $500,000 for which you’ve saved a $50,000 deposit. The actual cost of LMI usually depends on your LVR and amount of money you borrow.
The cost can also vary depending on the lender. When you’re talking to lenders about getting a home loan, make sure to ask how they calculate LMI and what the estimated cost may be.
If your loan with ANZ requires LMI, ANZ will arrange it and will tell you the cost of the premium and any additional information that may be required. You may also be charged stamp duty, depending on the State or Territory where the security property for your loan is located.
LMI vs more savings – which is better?
Many first home buyers debate whether it’s better to pay LMI or hold off on house hunting until they have saved up a bigger deposit. Every home buyer’s situation is unique – and the housing market can be volatile – so there’s no right or wrong answer here. You’ll need to decide the best option for you.
On the one hand, you may be keen to enter the property market because you are concerned property prices may be on the rise. In this case, if your deposit isn’t large enough, you may decide to pay LMI so you can buy your first home sooner.
On the other hand, you may be happy to wait for a year or so while you save more money for a deposit. The bigger your deposit, the less likely it is you’ll need to pay for LMI.
To sum up
- Generally, you may have to pay for LMI if your LVR is above 80%.
- LMI protects the lender if you default on your home loan and there’s a shortfall after the sale of the property.
- The cost of LMI can be paid as a lump sum – although some lenders may let it be added to your loan amount and paid off with your loan repayments (although in that case interest will be charged on the cost of the LMI).
Learn more about ANZ LMI with our Key Fact Sheet (PDF 370kB).