Is Lenders Mortgage Insurance a Bad Thing?
No one likes additional costs on anything they buy and for many LMI (Lenders Mortgage Insurance) is seen as an unnecessary evil that should be avoided at all costs.
So, what is LMI? LMI, as the name implies, is insurance for the lender not for you. Although it is a premium you pay it is designed to cover the lender should you fail to repay the loan. It is often a compulsory requirement from many lenders when you seek to borrow more than 80% of the value of a property. This is because their collateral, or the difference between the amount they have lent and the value of the property, becomes thin and there is a greater risk that if you should default they will not have sufficient value in the property should they need to sell and recover their money. On a property valued at $500,000, where the lender has advanced $450,000, they will feel that their selling costs, plus the risk of a drop in property prices, may make it difficult to recover their full loan. The lenders mortgage insurance will help cover for any shortfall.
Many will suggest you wait until you have sufficient deposit (normally 20%) to eliminate the need to take out LMI but is this necessarily the right thing to do?
The difference between a deposit of 10% and 20% can be quite substantial. On a property of $500,000 this represents $50,000. For a couple earning $100,000 per annum and having to pay taxes and living costs, it may take an additional five years to save up the difference.
What happens to the value of property during that time? Let’s assume property prices increase by 5% per annum. After year one that same property would cost them $525,000, by year 2 $550,000 (and that’s before taking into account the compounding affect!) and so on. By year 5 that property would be over 25% dearer – or more than $125,000 dearer than when they first started to save the deposit.
So, what if they had used the 10% deposit already saved and taken out LMI? The costs of the insurance is around 2-3% of the value of the property. On a $500,000 property, they might be looking at around $15,000 in LMI. As the example above shows however, the payment of an additional $15,000 in fees will see them save $125,000 on purchasing the same property in five years’ time. If they choose to wait they not only face a higher price but a higher level of deposit required. By purchasing now, not only could they get a foot hold in the market at a more affordable level, but they will gain $125,000 in equity by purchasing and holding the property.
To view LMI as a cost to be avoided is similar to assuming we should avoid paying interest on mortgages. Yet as has been shown time and again over the decades, borrowing money to purchase appreciating assets can be one of the most effective ways to build your wealth.
To discuss LMI and whether it could be the right option for your borrowing needs, please contact our team today.
All figures used in these examples are to illustrate only and do not represent any prediction of future financial gains.