Is Lender’s Mortgage Insurance a Necessary Evil?

They say cash is king.

When it comes to building a property portfolio you need lots of cash. Let’s take a look at a good way to keep your cash high and your options open.

We’ve all heard the age-old adage, ‘you’ve got to be in it, to win it’, and when it comes to investing in property, this couldn’t ring truer. But with property values rising faster than first home buyers can save deposits, Lender’s Mortgage Insurance (LMI) is fast becoming a necessary evil for those keen to get a foot in the door.

Lenders Mortgage Insurance (LMI) is a one-off insurance payment which protects your mortgage lender against your default. LMI is commonly paid when the Loan to Value Ratio (LVR) is 80% or more.

In our opinion, Lender’s Mortgage Insurance gets a bad wrap. Often pinned as the villain of home loans, LMI has some good qualities and gives you the option of purchasing property sooner or using LMI to buy a better home that they wouldn’t have been able to afford – for a cost of course.

The mortgage misconception surrounding LMI is that it has to be paid as a lump sum, upfront. This is not the case.

When structured properly, Lender’s Mortgage Insurance can be rolled into the loan amount, adding a small monthly premium to your repayments. Yes, it’s an additional cost, but the question you should be asking yourself is whether it’s a small price to pay for keeping your options open?

If you’re about to pour your finances into your first home or looking to extend your property portfolio, you’re looking at handing over a huge amount of hard earned cash. To help you keep some options up your sleeve, we’ve shed some light on ways to soften the blow and keep more of that precious cash in the bank.


The good


Aside from getting your property sooner, LMI allows you to preserve cash. If LMI is capitalised, you don’t need to pay a lump sum upfront, giving you more cash to invest later.


The bad


As LMI is calculated on the property’s value, purchasing property can cost you in the long run so spend smartly. Opting for LMI is essentially committing to slightly more risk, so before taking the plunge, do your research to make sure there’s ample opportunity for capital growth. At the end of the day, you’re paying the banks insurance policy so that they’re protected in case you default. The downside to defaulting is that you can’t get your property back.


The opportunity


For first home buyers, LMI reduces the amount of upfront capital you need to own your home, which means that you only need a 10 percent deposit.

For property investors, Lenders Mortgage Insurance lets you borrow more which lets you maximise the benefits of negative gearing. Most importantly, LMI gives you greater leverage to save your cash and use it to fund future investments.


A case study


We recently had a new client come though the doors telling us he was allergic to LMI and wanted to avoid the additional expense. When we explained he didn’t need to pay the fee out of cash his attitude changed immediately and started to see the opportunity.

The client’s objectives were:

Have available cash to renovate over time Keep payments as low as possible because his wife was pregnant and they were about to move to one income for 12 months. Have the ability to purchase additional investment properties within the next 5 years.

We sat down and worked through some options and our client was able to retain over $40,000 of his $100,000 deposit.

Scenario A Scenario B
Savings / Cash Equity

 

Purchase Price

Oncosts and stamp duty

Deposit

 

LVR

Lenders Mortgage Insurance

Final Loan Amount

$100,000

 

$435,000

$13,000

$87,000

 

80%

$0

$348,000

$100,000

 

$435,000

$13,000

$43,500

 

90%

$8,500

$400,000

Offset Account

 

 

Monthly Repayments

 

Monthly Repayments with offset account

$0

 

 

$1,305

 

$1,305

$43,500

 

 

$1,500

 

$1,337

Saving $0 $163

Money in the bank


In Scenario A the client is using all of their savings to achieve the smallest loan possible. Given the loan is at 80%, no LMI is payable. However by doing this, there was no cash left in the offset account, meaning no cash reserve for future investments or renovations. 

No cash means no flexibility and no opportunity.

In Scenario B, we were more modest about the use of capital to reduce the loan balance. We opted for 90% loan which attracted a LMI premium of $8,400.

By increasing the loan amount we’re retaining $43,500 in the cash reserve.

Maximum cash means maximum investment opportunities.


Capitalise the LMI


The client capitalised the LMI premium into the loan and now we pay an additional $32 per month on the loan to pay the premium.

For a nominal fee of $32 per month, the client was able to retain $43,500 worth of investment opportunity.


Offset to win


Interest is calculated by taking the loan balance, minus the balance of your offset account. By putting the $43,500 into the offset account the “assessable loan balance” is $356,500 ($400,000-$43,500).

Repayments now move from $1,500 per month to $1,337 a month, saving $163 per month.

In our opinion, LMI premiums are a case of minimal pain for long term gain. Handing over less of your hard earned cash frees up your future equity, giving you more ways to use your money to make money.

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