IF YOU'RE an observer, it’s been an exciting time to watch and hear about the rise and rise of Australia’s property market.
Still, many young Australians are spending their weekends looking for the house of their dreams - or have already found it.
Today’s property market is highly competitive, so it pays to be financially prepared and ready to act quickly – or miss out.
For most first-time buyers, it’s likely any new purchase will need to be financed.
Housing affordability has been decreasing and so obtaining a home loan is a daunting proposition.
Servicing ongoing repayments is a challenge, let-alone saving a hefty cash deposit plus upfront costs.
In previous articles, we have discussed the financial options available to families whom wish to collaborate and bring-forward the opportunity of the next generation owning their first home sooner.
There is another tool available to first-home buyers that is rarely discussed and not well understood.
It’s called Lenders Mortgage Insurance (LMI). LMI has helped make home loan finance available to millions of people. But like any financial strategy, LMI has its pros and cons.
Related Reading: 'A quick look at bank versus non-bank home loans'
How does LMI work?
LMI might allow you to borrow a higher percentage of the asking price, using a smaller deposit. With some lenders this means you could borrow up to 95% and not the traditional 80% i.e. cash deposit of 20%.
If a lender agrees to lend you more than 80% of a property’s value, there is a risk to them that if the loan is not repaid as agreed, they will lose money.
A lender benefits from arranging LMI to insure against the risk of this happening and to retrieve their money if a default occurred i.e. the insurance company pays the gap.
A one-off, up-front premium is charged by the insurance company to the lender, whom passes this cost to the borrower by capitalising it into the home loan.
LMI covers the full term of the home loan and is based on such factors as:
- Property value and location.
- Loan amount and level of equity.
- Level of risk.
The perceived convenience of LMI does come at a cost. Whilst it may mean you can act quickly on a house purchase by securing finance without a full 20% deposit, you’ll be borrowing more and therefore paying more interest over the term of the loan plus the principle cost of the up-front insurance premium.
The lender is covered, not you
A common misconception is that the borrower is covered in the event of a default.
Many people don’t realise that LMI protects the lender only. The borrower is still financially liable for repayment of the home loan and any defaults, even if a claim is paid to a lender by an insurance company.
If a secured property is sold due to default, the proceeds of the sale may not cover the outstanding loan balance.
The lender is then entitled to make an insurance claim for reimbursement of the shortfall.
NOTE: if a claim is paid to a lender, the insurer retains the legal right to seek recovery from the borrower for the shortfall amount paid to the lender.
Can LMI be avoided?
In a perfect world, something like LMI should be avoided. However, in today’s tough property market an entire generation of young Australians are considering all options available to buy their first home.
There are two ways to avoid paying LMI:
- Save for a big deposit i.e. 20% or more.
- Find a guarantor.
If you have been able to save a deposit of 20% or more of the property value, you will generally not be asked to pay for LMI. As a rule, the deposit will need to be genuine savings. If a deposit is ‘non-genuine’ e.g. parents have gifted an amount, it will pay to shop-around and find a non-bank lender willing to talk.
It’s normal practice that a person acting as guarantor will need to be a family member. The property acts as partial security and the equity in the guarantors property provides the additional security needed.
There are several risks associated with acting as a guarantor. Seeking good legal and financial advice is strongly recommended.
Related Reading: 'Mortgage versus home loan - do they mean the same thing?'
What are the benefits?
Most people want the Australian dream sooner than later, but will find their perfect home well before they have managed to save a 20% deposit.
By decreasing the lender’s risk, LMI has helped tens-of-thousands of first home buyers start building their personal wealth much sooner than ever thought possible – with as little as 5% deposit.
It’s estimated that as many as a quarter of home buyers now use LMI. A key reason is market risk.
LMI is very expensive however, if the property market remains strong and house values keep increasing, then LMI could be much cheaper now compared to the extra money needed to buy a home in a few years plus the extra cash deposit.
What are the costs?
As mentioned, LMI is expensive when applied to the average 25-30 year home loan term and premiums also attract GST.
The following example provides an estimate of the LMI premiums for a range of 30-year home loan amounts with a loan-to-value ratio of 95%, including the additional monthly loan repayment amount. Source: www.genworth.com.au
Property Value Loan Amount Insurance Premium Monthly Repayment
380000 361000 12100 93
480000 456000 15300 117
580000 551000 24850 191
680000 646000 29135 224
780000 741000 33400 256
880000 836000 37700 289
We’ve all been groomed to find a great deal and switch, but LMI could be costing you thousands more in new premiums. LMI is not portable or refundable if changing home loan lenders. Refinancing may cause you to pay it all again.
If you have multiple properties it can be considered splitting the properties into two or more loans and reducing the cost of the mortgage insurance premium. In the above scenario $741,000 loan combined with $33,400 premium. If there are multiple loans, say split $361,000 and $456,000 the premium totals $27,400 for a total borrowing of $817,000.
Summary
For an entire generation of young Australians, the milestone of home ownership is fading.
The challenge of saving a first deposit seems insurmountable and can significantly delay the purchase of a new home. What if values keep rising in the meantime?
The Australian property market is also very competitive and it pays to act quickly if you find the right property. LMI can help sort your finances sooner and bring you closer to home ownership - but convenience comes at a cost.
The right home loan is just as important as the right home. People currently looking for their first home will benefit from reviewing a number of different borrowing scenarios.
Are you ready to talk?
When it comes to home loans, there’s no such thing as one size fits all.
It pays to talk to someone that wants to hear your story and run through some different borrowing examples with you.
Why not incorporate a discussion about LMI as part of our free, no obligation financial review with one of our experienced and accredited professionals by organising an appointment today.
That’s right. In a refreshing twist you’ll actually talk to a real person.
It’s just one of the many features and benefits included in a tailored home loan solution from Loan Avenue – affordable home loan solutions for everyday Australians like you.
Let us show you. To take advantage and make an appointment call 1300 56 26 28 or leave a message here.
