Key points:
- Mortgage insurance protects the lender in case the borrower defaults
- Taking this insurance could help Australians enter the property market sooner
- It adds to the overall cost of purchasing a property
You've done your neighbourhood research, identified your dream home, pulled together finance for the deposit and are setting about the process of obtaining your home loan. Then the phrase "mortgage insurance" hits you.
So, what is mortgage insurance?
It is a significant aspect of the home loan process in Australia. While this insurance provides valuable protection for lenders, it's an additional cost for borrowers and doesn't offer any direct benefits.
What is mortgage insurance or LMI?
Mortgage insurance in Australia is a type of insurance that protects the lender, not the borrower.
Often referred to as Lenders Mortgage Insurance (LMI), it is designed to cover the lender in case the borrower defaults on the loan.
It is typically required when the borrower's deposit is less than 20% of the property's purchase price.
Why is mortgage insurance required?
Mortgage insurance is generally required by lenders when a borrower has a smaller deposit.
The reason behind this is that a smaller deposit increases the risk for the lender.
The insurance acts as a safety net, ensuring that if the borrower defaults on the loan and the sale of the property does not cover the outstanding loan amount, the lender can still recover some of their losses.
How does mortgage insurance work?
Cost and payment: Mortgage insurance is usually a one-off premium paid at the time of the loan settlement. The cost can vary significantly depending on the size of the loan, the amount of the deposit, and the lender's risk assessment. It can be added to the loan amount, increasing the total amount borrowed, or paid upfront by the borrower.
Coverage: The insurance covers the lender, not the borrower. If the borrower defaults and the property is sold but doesn't cover the full loan amount, the insurance pays the lender the difference, up to the insured amount.
Refunds: In most cases, mortgage insurance premiums are non-refundable. If you repay the loan early or refinance, you typically won't get a refund on the insurance premium already paid.
When is mortgage insurance required?
Mortgage insurance is commonly required in the following situations:
Deposit less than 20%: If your deposit is less than 20% of the property's value, lenders generally require mortgage insurance. This is because a lower deposit means a higher loan-to-value ratio (LVR), which increases the lender's risk.
High loan-to-value ratio (LVR): Even if your deposit is slightly above 20%, lenders may still require mortgage insurance if the LVR is high, particularly in cases where the deposit is close to the minimum threshold.
High-risk borrowers: Lenders may also require mortgage insurance for borrowers with a higher risk profile, such as those with a poor credit history or irregular income.
Who pays for mortgage insurance?
Typically, the borrower is responsible for paying the mortgage insurance premium.
This cost is either added to the loan amount or paid upfront, depending on the lender's policies and the borrower's preference.
Benefits of mortgage insurance
Access to home ownership: For many Australians, mortgage insurance enables them to enter the property market sooner than they might be able to with a larger deposit.
Competitive interest rates: Some lenders offer competitive interest rates to borrowers who pay mortgage insurance, making it an attractive option for those who may not have a substantial deposit but still want favourable loan terms.
Drawbacks of mortgage insurance
Additional cost: Mortgage insurance adds to the overall cost of purchasing a property. This additional expense can be substantial, particularly for larger loans.
Protects the lender, not borrower: Since mortgage insurance protects the lender, the borrower does not receive any benefit from it.
Non-refundable: As previously mentioned, the premium is generally non-refundable, even if you pay off the loan early or refinance.
How to calculate mortgage insurance
The cost of mortgage insurance depends on several factors, including:
Loan amount: Higher loan amounts typically result in higher mortgage insurance premiums.
Deposit size: A smaller deposit increases the LVR and thus the cost of mortgage insurance.
Property value: The value of the property can influence the premium, as higher property values can result in higher insurance costs.
Most lenders or mortgage brokers can provide a mortgage insurance calculator or quote based on your specific loan details.
Alternatives to mortgage insurance
Larger deposit: The most straightforward way to avoid mortgage insurance is to save a larger deposit (at least 20% of the property value). This reduces the LVR and eliminates the need for insurance.
Guarantor loans: Some lenders offer loans with a guarantor, which can help borrowers secure a loan with a lower deposit and avoid mortgage insurance. A guarantor, typically a family member, agrees to cover the loan if the borrower defaults.
First home buyer programs: Various state and federal programs are available for first-time home buyers, some of which offer assistance with deposits or concessions on mortgage insurance.
