If you are a first home buyer you may have heard people mention the LMI fee and wonder what is lenders mortgage insurance, and ask yourself why it is being added to the loan.
Obviously you don’t really want the extra cost of the LMI fee, but on the other hand you do really want the home loan so it might not be something that you can avoid.
Like all insurances LMI does provide real protection, but it is for the lender not you (the borrower) and yet in most cases it’s the borrower that pays for the insurance.
So let’s find out more about what lenders mortgage insurance is and why some lenders use it.
What is Lenders’ Mortgage Insurance
Banks and lenders are always assessing risk, and with mortgages the dollar amounts are large and therefore the risk can be seen as larger too. This is especially the case when there is a lower deposit as it means any lowering of the house prices can mean the equity quickly vanishes.
We know that saving a 20% home deposit, even with KiwiSaver funds, remains difficult especially in the main centres where prices are higher.
Lenders mortgage Insurance (known as 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. LMI is often used in conjunction with the First Home Loans (supported by Kainga Ora) where they charge 1% as a LMI charge.
Most banks no longer charge the LMI for over 80% lending as they have decided instead to charge a low equity premium (LEP) or low equity margin (LEM) which effectively allows them to self manage the risk.
The fact is that lenders mortgage insurance is really for the lender, not you the borrower.
The only reason that you ‘need’ lenders mortgage insurance is because the lender wants to remove (transfer) the risk and so they have made the insurance a condition of getting the mortgage.
Banks will generally be comfortable lending up to 80% of a property value or purchase price especially in larger towns and cities where there are enough house sales, but when they go above this level the risk increases. The risk that if the property is sold in a forced sale situation then the proceeds from the sale may not cover all of the remaining money owing and especially if the loan has been in arrears (in default) for a period of time.
Lenders mortgage insurance helps mitigate this risk for the lender as it insures against the loss.
The lenders do need to make sure that the mortgage application fits their own criteria, but also that of the lenders insurer and sometimes the insurance companies policies are tougher than the banks as it is the insurer who takes the most risk and therefore stands to lose money if things turn sour.
First Home Buyers Pay More
Many first home buyers are not going to have a 20% deposit.
It’s a fact of life and has been for many years, but even good savers are going to struggle to save enough deposit. The banks assess the deposit as a percentage of the purchase price so while $100,000 may be a 20% deposit on a first home purchased for $500,000, it’s under 15% deposit on a $750,000 home.
When you have less than 20% deposit you are deemed a higher risk, and because of that the banks do penalise you potentially in three ways:
- You often will have to pay a higher interest rate
- You will get less (if any) cash contribution
- You may need to pay the lenders mortgage insurance to protect the bank
These are the hidden costs that first home buyers often do not know about, and it’s not until your equity increases that you start getting treated more fairly by the banks.
Good mortgage advisers can help as they will know which banks can offer the better deals at any particular time. The banks are always trying to get more business, and you should consider some of the smaller banks and even non-bank lenders as they can often be the best for first home buyers and have packages specifically designed for them.
Learning about things like lenders mortgage insurance gives you a smarter start in your pathway to home ownership.