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Lenders mortgage insurance (LMI)

Marty McDonald - Monday, March 28, 2011

What exactly is lenders mortgage insurance? Lenders mortgage insurance covers a lender if there is an actual loss resulting from a loan, it does not cover the borrower in any way. The borrower is required to pay the mortgage insurance cost when setting up their loan or it can be capitalised into the loan amount. It is a one off charge which is currently not transferrable between lenders if you refinance even though most lenders use the same two insurers.

While initially it may seem unfair that the borrower covers the cost of insurance which in turn covers the lenders risk in reality the lender would not be willing in most cases to make these loans without the insurance cover. So LMI is a necessary evil so to speak for about 1 in 5 Australian borrowers who's loans require cover.

How does a lender use mortgage insurance?

If a borrower cannot make their repayments for an extended period of time and has no way of getting back up to date on their loan eventually a lender will be forced to sell the property (this is a mortgagee in possession sale). If the lender cannot recover the full loan amount outstanding plus their legal fees from the sale proceeds the shortfall will covered by the lenders’ mortgage insurance provider assuming the loan was covered by LMI from the outset.

For example say a lender lent a borrower $400,000 (including mortgage insurance) to purchase a $430,000 home and the borrower was unfortunately unable to pay their loan for an extended period. The lender would eventually be forced to sell the property to recoup their loan. If when selling the property the lender was only able to recover say $380,000 the resulting $20,000 loss would be covered by the insurer.

I often get asked how much is mortgage insurance? The answer to this question depends on 4 variables.

  • The actual loan amount being borrowed.
  • The loan to value ratio (the loan amount divided by property value expressed as a percentage).
  • Your loan type.
  • The lender / mortgage insurer chosen

Lenders mortgage insurance is based on the perceived riskiness of the loan. An $800,000 loan to purchase an $850,000 house is considered far more risky than $300,000 loan to purchase a $350,000 house even though in these examples the amount of equity is the same at $50,000. The loan to value ratio on the $800,000 loan is 94% while the loan to value ratio on the $300,000 loan is 85%. As the loan amount and loan to value ratio is much higher on the $800,000 loan the borrower in this example could expect the difference in mortgage insurance to be upwards of $18,000.

The risk associated with a loan can also be attributed to the type of loan for example a lo doc loan has a higher risk to the lender than a fully documented loan for obvious reasons. As a result lenders mortgage insurance is usually required on a lo doc loan if borrowing more than 60% or 70% of the value of the property and the maximum loan to value ratio is usually restricted to 80%. This differs to full doc loans where insurance is only required when borrowing over 80% of the value of a property and can be available for loans of up to 95% of the value of a property.

Finally from a borrowers perspective there can often be huge differences in mortgage insurance fees charged between lenders. This can be the result of which insurer the lender uses, the deal they have their insurer(s) and how the lender calculates the insurance premium.

For more on mortgage insurance including examples of how much mortgage insurance would be in a given scenario as well as a typical mortgage insurance premium table please click on the links below.

Lenders mortgage insurance
How much is mortgage insurance?

If you have any other questions relating to LMI please feel to contact me via the enquire online pages, the contact us page or by calling on 1300 711 054


Thanks,

Marty McDonald

About the Author: Marty McDonald is principal of mortgage broker “Mortgage Experts”. Marty specialises in assisting active property investors with loan structuring advice and implementation as well as helping credit worthy borrowers with slightly outside the box income and employment situations. Find Marty on and LinkedIn.

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