Lenders Mortgage Insurance; good, bad or just the cost of doing business?

You’ve heard of this devilish thing called LMI, but what is it and should you avoid it at all cost?

When you borrow money from a bank for a home, the bank won’t lend you the full amount, because that would mean they take all the risk. Ideally they would like to lend you 80% of the value of the house, because if you stop paying your repayments and they need to sell the house; they can easily get enough for it to cover your mortgage. If the bank lends you more more then 80%, there is more risk for them that in case you don’t pay your repayments and they need to sell the house in a hurry, that they can’t get the amount for it to cover the mortgage. So for this risk the bank takes out insurance and you get to pay the premium for this insurance.

Let’s look at an example. Let’s look at a $450000 package - so the bank values your house and land package at the cost price (read more about valuation issues here). If you were to borrow 90% secured agains this home, so your mortgage would be $405000 and your deposit is $45000; the Lenders Mortgage Insurance on this would be around $7100. If you were to borrow more though, let’s say 95%; so your mortgage being $427500 and your deposit $22500, then your LMI would be some $14150.

So to keep $22500 more in your pocket, you get an extra $7000 or so being added to your mortgage. If that’s the difference between getting a home or not, it’s worth paying. If saving the rest of what you need to avoid the LMI will take you a long time: you might lose out more on growth then the LMI would cost you - or in ther words: what you think you won in not having to pay LMI, you have lost by now having to pay more for you land.

If having to pay LMI is the difference between getting one investment property or two; that second property should make you more money in capital gain than the LMI costs you! It’s just the cost of doing business.

Have the conversation with your broker and line up what is the best way for you to go. Maybe you can avoid the LMI or a high amount of LMI by putting in more of a deposit, maybe you’re better served keeping your money in you pocket and getting the LMI added on. Just avoid the trap of blindly saving until you reach the point that you don’t have to pay LMI; you might miss out on a lot off opportunities and lose out on more opportunity then you save!