What exactly is lender’s mortgage insurance (LMI) and whose interests does it protect?
According to a report released by two of Australia’s largest mortgage insurance providers, about 70% of borrowers believe LMI protects them in the event of a default. This is not correct. LMI is an insurance designed to protect the lender.
Mortgage protection insurance, by contrast, provides the borrower with protection in case of a loan default. In unforeseen circumstances, such as unemployment, illness or death, this insurance will provide the borrower with the means to continue paying the monthly instalments.
Who uses Lender’s Mortgage Insurance?
Organisations providing loans to borrowers looking to buy property take out lender’s mortgage insurance. This includes Banks, Credit Unions, Building Societies and alternative lending companies. LMI is subject to heavy government regulation.
Often financial institutes will make LMI a condition of the loan. Without it there is no loan.
Is Lender’s Mortgage Insurance of any benefit to the borrower?
In some ways LMI does help the borrower. Prior to LMI, many lender’s required a deposit of about 20% to safeguard its interests in the event of a default. This requirement protected the lender in situations where property prices fall. If the property sells for less than anticipated the deposit covers the shortfall.
However, with this shortfall risk covered by lender’s mortgage insurance, lenders are now willing to reduce the deposit amount required. In some cases lenders will not require any deposit. Also, lower mortgage interest rates are possible. And in some instances, lenders approve higher loan amounts.
What does this mean for the borrower? Firstly, home loans are accessible to more people. Secondly, borrowers are able to buy a home earlier. And finally, they are often able to buy a better quality property than before when higher down payments were necessary.
Who gets to pay the Lender’s Mortgage Insurance?
The lender approaches the LMI provider. However, the borrower usually pays the insurance premium as part of the cost of incurring the loan. This can take the form of a once off, upfront payment. Or the LMI is included in the loan total and paid over a period.
What determines the cost of the Lender’s Mortgage Insurance?
The amount varies and the following play a role:
- The size of the loan: the bigger the loan the bigger the risk to the lender. Therefore, larger loans result in higher LMI costs.
- The amount of deposit paid: the larger the deposit amount the less the risk to the lender so the lower the cost of the LMI.
- Employment status: a casual employee has a higher risk profile resulting in a higher LMI premium. By contrast, a borrower with full-time employment may pay less in LMI.
- The insurance provider: different providers of lender’s mortgage insurance offer different premium options.
The details of lender’s mortgage insurance often hide in the fine print of a loan contract. This results in much confusion on the part of the borrower. If addressed at the beginning of the loan negotiation process, the borrower’s understanding will be better. It is advisable to fully disclosure the purpose of LMI to the borrower.
This publication is for your general information and interest only. It is therefore not intended to be comprehensive, and does not constitute and must not be relied on as legal advice. You must seek advice tailored to your specific circumstances.