How to Avoid Mortgage Insurance or at least reduce it!
Home/How to Avoid Mortgage Insurance or at least reduce it!
Learn how to avoid mortgage insurance, or at least reduce it, to save you thousands of dollars and it may get you into a home sooner.
Here we discuss how to avoid mortgage insurance and if you can’t avoid it, then we show you several ways to reduce lenders mortgage insurance. We also offer a free no-obligation 20 min conversation to talk through your scenario if you think this loan type might be suitable for you . Enjoy reading this and if you like it, please share or add a comment.
Section 1 gives you the background but if you know this, skip straight to section 2 for tips on reducing LMI.
Section 1. What is mortgage insurance?
The formal term is actually Lenders Mortgage Insurance (LMI) and it’s an insurance product that protects the mortgage lender in the event that the borrower cannot fully repay their loan. It’s applied to Full Document loans where the Loan To Valuation Ratio (LVR) is higher than 80% and to Low Document loans, where the LVR is higher than 60%.
Is it here to stay and can I avoid it?
Yes. It was a government initiative started in the 60’s to help low-income earners obtain housing finance by insuring lenders against the costs of mortgage defaults. Today it’s used in Australia, Canada, Hong Kong, the Netherlands and the United States so yes its here to stay. Can you avoid mortgage insurance, yes there are a couple of ways and if you can’t make it happen, there are ways to at least reduce it.
Why is mortgage insurance needed?
A few reasons:
It still allows people with smaller deposits that normally would not be accepted due to the higher risk, to be able to buy earlier. LMI is risk protection for a bank in the event you don’t make payments and the property is sold at a loss, so reducing their risk means that they can lend more broadly.
It gives banks better rankings. If a big portion of their loans is high risk and without insurance, their ranking may get downgraded which has major ramifications for them.
It protects our financial system against potential major failure. It’s estimated that ¼ of all homes in Australia have LMI and if there was a dramatic drop in property values with high foreclosures, our lenders could potentially fail and affect others too.
Is mortgage insurance compulsory?
Technically insurance is not compulsory and under a few limited policies, some lenders allow the reduction or removal of LMI conditions where other mitigants reduce their risk exposure. We will help you assess if you qualify.
How much does mortgage insurance cost?
Insurance is calculated on a complex Matrix for each lender with the rate increasing incrementally depending on the LVR % and amount borrowed. Example of LMI costs and the sliding increments:
An 81% LVR loan for $100,000 may cost around 0.45% ($450)
A $500,000 loan at 81% LVR may cost around 0.59% (2,950)
A $500,000 loan at 89% LVR may cost around 1.55% (7,750)
A $500,000 loan at 95% LVR may cost around 3.04% (15,200)
A $770,000 loan at 95% LVR may cost around 4.18% (32,186)
Stamp duty of 5% to 11% is payable in addition. These are indicative examples only. There are many variances and loadings between the insurers and lenders. Our qualified mortgage specialists will calculate the exact costs for you and find which options will save you money.
When do I pay mortgage insurance?
LMI is paid at the time of settlement of the property. It’s a once of premium that can often be capitalised (added) onto your loan.
Is the insurance the same cost for all lenders?
No. The insurers have a different premium matrix so one might be cheaper for $300,000 at 85% LVR, whereas another might be cheaper for $300,000 at 90% LVR. First home owners might get different rates and lenders also add a margin to the premiums so there is great variance and a need to work with a specialist broker to match the criteria to your needs and the best rates.
Section 2. Tips on how to avoid mortgage insurance?
Tip 1. If you qualify, you can avoid mortgage insurance up to 85% LVR
If your loan is under 85% LVR there is one lender that may accept you with no LMI payment. They actually pay the insurance themself and wear the cost provided you meet their strict guidelines of risk reduction, being:
Completely clean credit history
Primary applicant must be Australian resident or Permanent resident
Good conduct on all existing accounts including Diners Club
Property must be in a Major metropolitan or City area
Strata units must be >5 years old
No land, acreage, construction or rural residential properties
Minimum $200,000 loan and maximum $800,000 in NSW, Vic and ACT, $500,000 in other states
All funds for the purchase, no cash for other purposes
Tip 2. If you can use a family guarantor you may also be able to totally avoid mortgage insurance
The main trigger for requiring insurance is where the LVR is above 80% (60% for Low Doc). By having a family member provide additional equity against their own property, you may be borrowing up to 100% of the value of your new property, but because the family is giving a guarantee for 20%, the risk to the bank remains at 80%.
Ideally the guarantor is a mother, father, grandmother, grandfather although brothers, sisters and step relationships can be considered. The family member must have sufficient free equity in their property and have an income source, even if it’s in retirement funds. See www.staging.financeprofessionals.com.au/family-pledge-loans for more information. Some of the tips below may get you to the threshold to avoid mortgage insurance, or at least reduce it.
Contact us to help you determine what is possible for your circumstances.
Tip 3. Work the LMI Matrix to reduce or avoid mortgage insurance
Mortgage Insurance is calculated using a matrix and on one Axis is the LVR% and on the other is the loan amount $. The higher in each the rate goes up and if you go higher in both, it grows even faster.
Each rate is then placed in a block, a range, so simply moving down into a lower range can drop you into a lower rate eg. 89.9% LVR is much cheaper than 90% and on a $350,000 loan, this means putting just $350 extra in to potentially move you from a 2.75% rate down to 1.91% rate, saving you $2,940. Even if you had to put the extra $350 deposit on a credit card, it would save you that amount many times over. (See Green example below).
In other cases, the saving is only small, so you might want to borrow the most you can within the Matrix block, to have some extra money for renovations or furniture see pink example below. A skilled broker will check where you are on the matrix and calculate how much you need to put in extra, to get you to a lower Insurance rate. Here is an example of a Matrix. They aren’t published anymore and rates have risen and vary between lenders, but you can see the effect of the matrix and the benefit of moving down where you can.
Tip 4. Negotiate harder or buy a cheaper property
The example above, shows that moving down a Matrix block can save you money. If you wanted a $580,000 property and needed say a $500,000 loan you would be in the 86.2% pink block above and pay $4,585 insurance. If you negotiated hard to say $560,000 and now only needed a $480,000, the LVR drops to 85.7%, you now pay $3,885 insurance so save another $700.
Better still if you drop from a $300,000 loan instead of a $310,000 loan and have the same LVR of say 84%, you drop from 1.10% down to 0.89% so save yourself $651 in insurance.
Tip 5. Stage the borrowing
If you are planning to renovate or add value to your new property, you could choose to stage the renovations so that as the property value increases your LVR stays lower. As an example: Scenario 1. $500,000 purchase needing $360,000 loan plus another $80,000 for renovations = $440,000 total lending. Total LVR would be 88% so 1.31% rate, being $5,764 insurance payable. Scenario 2.
As above, but borrowing $360,000 plus $40,000 for renovations so 80% LVR and no LMI. Upon completing renovations you get the house revalued to say $550,000. You then borrow another $40,000 to complete the renovations so $440,000 lending in total on a $550,000 value, so 80% LVR and you still avoid the Lenders Mortgage Insurance :-)
The above scenario does rely on getting the favourable valuation so you would want to start with the renovations that added tangible value to the property.
Tip 6. Sell something for more deposit
Lets assume you are buying a property for $620,000 and need to borrow $500,000 plus $30,000 for stamp duty, conveyancing and moving. Total borrowing $530,000 so 85.48% LVR meaning 1.11% rate so $5,883 LMI. In this scenario, you could avoid the LMI totally if you had another $30,000. Now you might have a second car, or a boat or even have some shares that you have been holding onto.
Something to consider is that even if you forewent some value of the item you are selling, you will avoid paying the $5,883. If you were planning on holding shares as an example, they would have to appreciate 19% in a year, to recoup the money you could save with LMI. You will need to prove to the bank that you have the available funds at the time of application. Shares based on current value are usually acceptable but if selling a boat, this would have to be done and money in the bank, before you applied if you want a formal approval.
Tip 7. Save more and come back later
As you can see in the above example, $30,000 extra savings made a $5,883 reduction in insurance, so consider saving more aggressively to get into the house sooner, or wait until you have the $30,000 to save the insurance totally. If its going to take you another year to save this money and the real estate market is moving or you have a great buying opportunity, it may be cheaper to just pay the insurance, but always worth considering.
Tip 8. If you own multiple properties, look to re-shuffle your portfolio
If you need money for renovations or another property, rather than be limited to the equity on say property A, look to borrow some of the money against Property B, to use for A to keep the LVR down and minimise the insurance. Valuations will be key but a seasoned broker will be able to help calculate the numbers, likely LMI scenarios and guide you to the most cost effective solution.
Tip 9. As a last resort, use your credit card
Sometimes just a few thousand dollars will get you down to a lower insurance rate. If this is the case you could consider paying for the conveyancing fees, moving costs and even another $1,000 or so on your credit card to drop you to a lower rate. This is a strategy of ‘last resort’ because most credit cards are between 12% and 20% but particularly where you are expecting more money soon, a bonus or a payrise after you have purchased, then this is a strategy to consider.
As an example: You are purchasing for $550,000, you need to borrow $480,000 plus $5,000 (conveyancing, moving) so LVR is 88.2% being a 1.78% rate and $8,633 insurance. You can reduce the mortgage insurance by paying the $5,000 in costs via credit card, so you stay with a $480,000 loan at 87.3%, so 1.31% rate and $6,288 insurance. This saves you $2,345 in insurance! Even at 20% credit card interest, if it took a year to pay off the card, this would cost $500 in interest but save you $2,345 in insurance.
FINAL NOTE OF WARNING: You should always try to build in a buffer on your purchase so trying to over-manage it to save mortgage insurance, could mean you fall short at settlement or soon after. Unexpected bank fees for the settlement, extra legal costs, moving costs increase, house insurance costs, hot water system breaks the day you move in etc can all happen unexpectedly and need payment instantly so its always wise to build in a buffer, even if you pay a little more mortgage insurance.
An experienced broker will help you work through these issues, save you time and money, so book a phone meeting now to get started.
You can also complete the form below to receive a copy of our special report on saving LMI.