What is Lenders’ Mortgage Insurance and How Does it Work?

What is lenders’ mortgage insurance, how does it work, and who has to pay it? Canstar explains all you need to know about LMI and how it can help you get into a first home sooner.

First home buyers are out in record numbers at the moment. According to Corelogic’s latest property market update, first home buyers are at historic levels, making up a quarter of the market. But despite low interest rates, thanks to rampant house price inflation over recent years, saving for a home deposit remains a Herculean task.

However, if you’re finding saving a large deposit difficult, don’t despair. Thanks to lenders’ mortgage insurance (LMI), you don’t necessarily need a 20% deposit to buy a home.

In this article:

What is lenders’ mortgage insurance?

LMI is an insurance policy that protects the lender from financial loss in the event that the borrower can’t keep up their home repayments. Although the term LMI is often used, especially in conjunction with Housing New Zealand’s First Home Loan Scheme, it’s also often referred to as a low equity premium (LEP).

Don’t confuse LMI with mortgage protection insurance, which is an optional type of income protection insurance. Mortgage repayment protection insurance provides cover for your mortgage repayments if you become sick or disabled, die or lose your job.

Lenders’ mortgage insurance is not optional. If you are a high loan-to-value borrower, you will have to pay it as part of your mortgage.

The cost of the LMI/LEP is charged as either extra interest, or an additional one-off charge, on top of your mortgage. Depending on the size of your deposit and your lender, it can range from an extra 0.25% to 1.5% per annum, or a 2% premium on the amount of your loan.

If you load the premium onto your mortgage, you will pay interest on the premium for the life of your loan. On a $500,000 loan, the LMI one-off payment could range from $1250 to $10,000 extra on the size of your loan.

However, if the LMI is charged as extra interest, you only pay the additional rate while your equity in your home remains below the LMI threshold. As your equity grows, you can apply for the LMI to be reduced and, ultimately, dropped.

When is lenders’ mortgage insurance required?

Generally, a lender will require you to pay LMI if your home loan deposit is less than 20% of the total value of the property. A graded system applies. The bigger your deposit, the less you’ll pay. The scale covers a range of deposits from 5% up to the usual 20% deposit mark.

If you haven’t got a 20% deposit, your lender might also charge you a higher interest rate on top of the LMI, hitting you twice. Therefore, it’s worth doing your homework and assessing all your options.

Always shop around for the best deals in the market – Canstar’s home-loan comparison tables are a great tool. And, if you don’t have a big enough deposit saved, consider postponing your home-buying aspirations. Making a few extra sacrifices now to bolster your deposit, could save you thousands of dollars further down the track.

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What affects the cost of lenders' mortgage insurance?

Lenders’ mortgage insurance: the costs

For those with less than a 20% deposit, three of the four major banks charge annual extra interest charges:

(All figures correct as of 08/12/2020):

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Fixed 1-year rate: 2.49% p.a. (Minimum 20% equity)

Standard fixed 1-year rate: 2.49% p.a.

Low Equity Premium:

  • 80.01% – 85% LVR: 0.35% of loan amount p.a.
  • 85.01% – 90% LVR: 0.75% p.a.
  • 90.01% – 95% LVR: 1% p.a.
  • Over 95.01% LVR: 1.15% p.a.

Fixed 1-year rate: 2.49% p.a. (Minimum 20% equity)

Low Equity Premium:

  • 80.01% – 85% LVR: 0.3% of loan amount p.a.
  • 85.01% – 90% LVR: 0.75% p.a.
  • 90.01% – 95% LVR: 1.3% p.a.
  • Over 95.01% LVR: 1.5% p.a.

Special fixed 1-year rate: 2.49% p.a. (Minimum 20% equity)

Standard fixed 1-year rate: 3.09% p.a.

Low Equity Premium: 0.25% – 1.5% p.a. depending on size of deposit

As you can see from the above figures, if you’ve less than a 10% deposit, you could end up paying a lot more than a bank’s special rate. For example, at Westpac, your interest rate could be as high as 4.59% – 2.1 percentage points higher than their attention-grabbing special fixed 1-year rate of 2.49%

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Over at the ANZ and Kiwibank, the low equity premium is charged as a one-off fee, which can be added onto your loan. As you can see below, those with less than a 10% deposit have to pay substantially more for their mortgage.

Special fixed 1-year rate: 2.49% p.a. (Minimum 20% equity)

Standard fixed 1-year rate: 3.09% p.a.

Low Equity Premium:

  • 80.01% – 85% LVR: 0.25% of loan amount
  • 85.01% – 90% LVR: 0.75%
  • Over 90.01% LVR: 2%

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Special fixed 1-year rate: 2.55% p.a. (More than 20% equity)

Standard fixed 1-year rate: 3.3% p.a. (Less than 20% equity)

Low Equity Premium:

  • 90.01% – 95% LVR: 0.25%

First Home Loan

A First Home Loan is a special home loan for first home buyers, which only requires a 5% deposit. First Home Loans are underwritten by Housing New Zealand (a government corporation) and are issued by several lenders. These include: Westpac, TSB, Kiwibank, The Co-Operative Bank, and the SBS Bank. Because of the low deposit, you’re required to pay a LMI levy of 1% of your mortgage amount, which can be rolled into the loan.

How to avoid Lenders' Mortgage Insurance

How to avoid lenders’ mortgage insurance

Is it possible to buy a house without paying LMI? Absolutely! You could:

  • Grow your deposit – there’s one simple way to avoid LMI, and that’s to save a 20% deposit. If saving is proving tough, consider setting your sights on a more affordable home, or apartment.
  • Ask your parents for cash – if you’re lucky enough to have willing parents with deep enough pockets, you could consider asking them for help with your deposit, or to co-purchase the home with you. For more on the pitfalls of parental assistance, check out our story: Buying A First Home? The Bank of Mum and Dad Can Help!
  • Ask family to act as a guarantor – if parents or relatives have enough equity in a property, they can use that as security to help you obtain a mortgage, by making up a percentage of your deposit.

Not all bad news

Yes, if you’ve less than a 20% deposit, it’s likely you’ll have to pay more for your mortgage, but it isn’t all bad news. Due to the way that LMI is calculated, as you pay off your loan and, hopefully your property rises in value, your LMI should diminish as your equity in your home rises. For a more detailed case study, check out our story: Low Deposit Home Loans Come With A Costly Catch.

To ensure that you’re not out of pocket, you’ll need to keep a close eye on house prices in your area and the size of your debt. Banks won’t actively revise the LMI that you’re paying, unless you contact them and ask for a re-evaluation of the price of your home and your equity in it.

Ultimately, it pays to shop around. If you’ve a stable income and a good savings history, you could be able to negotiate a great deal even without a 20% deposit.

So make sure you do plenty of research before making a purchase decision. And that involves taking time to compare the different home loans available to you, which Canstar can help you with. Our comparison tables are easy-to-use tools that feature the best and most competitive deals in the market. Our expert research team awards the best our expert 5-Star ratings. To read more about our five-star home loan awards click here, or to compare rates using our free mortgage comparison tool hit this button:

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