What LMI covers and who uses it
Lenders’ mortgage insurance (LMI) is specialist commercial insurance that a lender buys to insure itself against the risk of not recovering the full loan balance if a residential borrower defaults on their home loan payments, and the proceeds from the sale of the property are not sufficient to repay the outstanding debt. It is important to understand that LMI covers the lender and not the borrower.
Although LMI protects the lender, LMI also provides borrowers with important benefits. LMI enables borrowers to access home loans from lenders when they meet the lending requirements, but do not have the required deposit, typically 20 per cent of the purchase price.
It is important to understand that LMI is very different to mortgage protection insurance, which protects a borrower by making certain mortgage repayments on their behalf or paying off a lump sum of the mortgage in certain circumstances, such as involuntary unemployment, sickness, accident or death.
Frequently asked questions (FAQs)
LMI is typically purchased by a lender when a borrower, who is otherwise credit worthy, has not saved a substantial deposit (typically 20 per cent of the value of the residential property). Due to the small deposit, the amount borrowed is high compared to the value of the property (high loan to value ratio loans). These loans are riskier and capital intensive for lenders.
With the expertise and support of LMI, more lenders are prepared to participate in and compete for residential mortgage lending business, particularly high LVR lending. By using LMI, lenders can pass on this risk to a specialised mortgage insurer. Many lenders would otherwise not have the risk appetite, expertise or capacity in this segment.
The lender will pay the LMI premium to the insurer as a single, up-front premium at the commencement of the policy, which is usually on settlement of the mortgage. LMI provides protection to the lender for the entire life of that loan (which can be up to 30-years). The cost of the LMI premium is usually passed on by the lender to the borrower as a fee. Borrowers pay the LMI fee upfront and often capitalise this cost into their loan amount.
LMI premiums are ’community rated’. This means the cost of LMI predominantly depends on the loan size and LVR rather than borrower characteristics, such as employment type, location or credit score. This is an advantage for many borrowers because it increases the accessibility and affordability of home loans. There may also be loadings, such as for invest loans or discounts, typically for first homebuyer loans.
Before LMI was available, lenders required borrowers to contribute a large deposit to the purchase of a property. This was to protect the lender in the event of default by the borrower, ensuring that the proceeds from the sale of the property would be adequate to cover the total outstanding debt owed to the lender.
With the ability to use LMI to insure the risk that there might be a shortfall after the sale of the property, lenders have been prepared to lend more, accept a lower deposit and also to offer lower interest rates for mortgages than they would otherwise be able to offer borrowers. As a result, cost effective home loans are available to more people, enabling more people to achieve the dream of homeownership.
LMI was originally introduced by the Australian Government in 1965 to increase access to home ownership for families and first-time home buyers. Australia is unique as, here, LMI is solely provided by private insurers. In other countries, LMI is either provided by government-owned insurers, government-guaranteed private insurers or a combination of government and private insurers.