How many of you have heard that LMI is bad? I find that most people who come to me and ask for advice on property and their big concern is LMI, more often than not, they are new to the property game or they just don’t understand finance in real estate.
But don’t worry! We are here to help you make sense of this property world.
Someone who doesn't know much about property will tell you to avoid LMI at all costs, because - well who wouldnt avoid an unnecessary fee if they could, right?
Well this is a perfect example of "BBQ Advice" that doesn't suit everyone.
First let me start by stating that LMI is one of the most misunderstood elements to buying property as it is labelled as a “foe” but it should be labelled as a “friend”.
LMI or lenders mortgage insurance is an insurance premium the banks will charge on top of your loan when you go above a certain LVR (loan to value ratio), normally it is anything above 80%.
LMI does not protect you, it protects the banks themselves if you default on your loan repayments. The cost of LMI varies depending on each lender, your loan amount and your LVR %. For example, if you have an LVR at 85% you may get charged a LMI fee of $2,300, but if you borrow 90% you may get charged $6,000. The LVR level at which you start being charged can sometimes depend on your job & income, eg. some lenders allow doctors to borrow up to 90% before they start getting charged LMI.
One thing most people don’t understand is that this LMI fee is often ADDED onto the loan. Meaning you don’t have to part with your own cash. Therefore, you would essentially be splitting the $6k fee over a 30 year span, so basically it could cost you an extra $16 a month.
Ok so why can it be my friend? – Well let’s look at 2 different scenarios to show you why.
First home buyers
As I’m sure most of you can understand that getting your foot in the door of the property market is a huge step and often it’s the hardest step to take. Buying your first home traditionally means you need to save up a big deposit and to stay out of LMI territory, you would need at least 20% of the purchase price. Therefore, on a $500,000 property, you will need to save $100,000 (plus purchasing costs stamp duty etc).
Now I don’t know about you, but it seems to me that the world we live in today typically involves people buying what they want before they get the money for it. Meaning people are saving less and spending more on credit. Therefore, getting a $100k savings for your first house can be a pretty unachievable feat for most.
Well, what can you do? Most first home buyers are purchasing using a 95% LVR and getting into their home with a minimal deposit. Thus, you can get into your $500k home with only $25,000 deposit (plus stamp duty etc) and add a LMI premium on top of the loan.
Scenario 1. Save for years to get a $100k deposit + spend more years renting (spending dead money)
Scenario 2. Get into first home $25k deposit – add LMI fee of $10k to your total loan amount and start paying off your mortgage instead of rent.
That saves you at least $75,000 PLUS the thousands you could spend on renting for a longer period whilst trying to save that full 20%.
It’s a no brainer. Yes! your loan amount will be higher, BUT, wouldn’t you rather spend an extra $100 a week paying down your mortgage and building equity in your home, than paying off someone elses?
Investors
Cash is king! Especially with investments. Generally speaking the more you borrow on investment loans the more tax deductions you will be able to claim against the property. Therefore, bigger debt and less deposit can work out best for the tax man.
LMI can allow you to grow your portfolio at an accelerated rate
Let’s say you had $100k for a deposit on an investment property. You could buy one investment property for $500k and not pay any LMI- yippee!
OR
You could put a deposit of only $50k down and add an LMI fee on top of your loan of, let’s say $8k. That way you still have $50k cash in your back pocket to use. PLUS you could put this $50k into an offset account and offset $50k worth of interest you would pay on your loan.
OR
You could split your $100k 2 ways and use $50k as a deposit on one property and $50k as a deposit on another. Therefore, you will end up with 2 investments and a small fee of LMI added to each loan.
Obviously, this depends largely on a number of things, like what your strategy is, your risk level and how much your serviceability is. But at the end of the day, what I’m getting at is that you can split your cash and increase your portfolio. This scenario would work best if the 2 investment properties were cash flow positive, that way, the extra $7-8k you get charged on top of your loan for LMI, would be covered by the rental yield you receive any way and it won’t impact your back pocket.
There are many ways to look at LMI as a positive for first home buyers and for investors, but the main thing is to talk to a professional to see if it suits your situation first of all. In summary from me, I think it is more than necessary for first home buyers and it is a great tool to help you leverage your portfolio at an accelerated rate for investors. Plus, LMI for investment loans is a tax deductable expense that can be claimed back over 5 years. BOOM!
Please understand the example numbers in this article are only examples and they do not take into account purchasing costs like stamp duty etc. It is just to get a basic understanding of the numbers and how LMI can help leverage you into the property market.
If there is anything else you wish to know about LMI, strategies or finance basics, then please feel free to contact us.
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