When you should pay lenders mortgage insurance

While many home buyers might be reluctant to pay lenders mortgage insurance (LMI) to achieve their property goals, it can be a useful tool in the current buyer’s market.

It’s not a black and white argument that LMI should always be avoided.

LMI insures your lender should you default on your home loan and is generally required if you borrow more than 80% of the value of a property. While it protects the lender if you stop making your mortgage payments, LMI also makes it possible for purchasers to buy a home with a deposit of less than 20%.

LMI involves paying a once-off fee to the lender, with the amount varying depending on the amount borrowed and the size of your deposit. You can pay the fee up-front or add it to the total loan amount.

While it’s generally preferable to have a 20% deposit for the purchase of a property, it’s not always possible to do so, particularly for first-home buyers.

It may be that LMI provides people with the ability to capitalise on some of the good buying opportunities that are currently available and get their first foot on the property ladder, rather than having to spend several more years renting and trying to save.

The key is to ensure that if you do take out LMI that you’re buying well and are prepared to stay in the property long-term to benefit from capital growth.

Take the example of a couple looking to purchase a property valued at $400,000 that last sold for $450,000 several years ago but has dropped in price due to the declining market.

To date they have saved $40,000 – $40,000 short of the $80,000 they need to have a 20% deposit and avoid paying LMI.

They are currently paying $380 a week in rent and saving an additional $200 a week. Saving $200 a week would mean it would take them just under four years to save up the additional $40,000 to have the full 20% deposit.

If they looked to purchase this property now with their current $40,000 used for the deposit and associated buying costs it would mean that they would need to borrow 94% and pay an LMI premium of $11,000.

In that same time period (four years), having bought the house now, the $580 a week in rent and savings would have seen them build up $50,000 equity in their own home (assuming a property growth rate of 3% a year).

In this scenario, while they have incurred an LMI premium of $11,000, it has allowed them to build up equity in their own home of $50,000.

This is a financially positive outcome and also has allowed them to have the satisfaction and security of buying their own home – for a good price – which they can then leverage off in the coming years to further build their wealth.

If you’re unsure whether to buy now or perhaps wait longer to save more of a deposit, an experienced mortgage adviser will be able to run the calculations for you and give you some advice based on your individual situation.

It might be that in some instances it’s better to delay your property purchasing plans for a while longer rather than buying now and paying LMI.

Talk with your mortgage adviser as a priority so they can advise you on the best course of action.

Graeme Inglis is an adviser at Smartline Home Loans Group