A recent report by Helia, Australia’s largest provider of Lender’s Mortgage Insurance (LMI), reveals that first-home buyers have “a mix of optimism and concern” in the current market environment.
A key obstacle for many is the difficulty in saving for a deposit.
One option for first-home buyers who don’t have (at least) a 20% deposit is LMI.
Around 90% of first-home buyers now consider LMI when thinking of buying a home and around 55% end up using LMI for a purchase. This is up from 73% and 36%, respectively, in 2023, according to Helia.
For many, it may seem a no-brainer to use LMI to buy a home sooner rather than wait to save for a deposit. But when you consider the total costs of LMI, the decision isn’t so straightforward.
LMI helps borrowers buy property sooner
LMI is insurance for mortgage lenders (not borrowers).
It protects lenders from the risk of loss due to borrowers not paying their home loan repayments in full (whereby lenders are unable to recover the outstanding loan amount from selling the secured property).
LMI allows borrowers to buy property when they don’t have the minimum deposit required, typically 20% of the purchased property value. If such borrowers purchase LMI, lenders are happy to lend up to (usually) 95% of the purchased property value, i.e., up to a loan-to-value ratio (LVR) of 95%.
In this way, LMI helps borrowers enter the property market earlier than they otherwise would as they don’t need to wait and save for a 20% deposit. But LMI comes at a cost in the form of a non-recoverable premium.
Many borrowers capitalise the LMI premium onto their mortgage, with the premium amount not impacting their LVR calculation. This allows them to enter the property market with smaller deposit amounts (i.e., less than 20%) and bundle the premium cost with their mortgage repayments.
The costs of LMI
But LMI premiums don’t come cheap.
LMI premiums for first-home buyers
Let’s consider an example. The LMI premium for a first-time home buyer with a 15% deposit (i.e., 85% LVR), assuming they’re an owner-occupier purchasing a property worth $500,000 (and a 30-year loan term), is approximately $4,700. This is based on Helia’s LMI fee estimator.
This LMI premium adds nearly 1% to the cost of buying the property.
Consider the same buyer with only a 5% deposit (i.e., 95% LVR). The LMI premium would increase to nearly $15,000, or 3% of the property value.
So, LMI premiums add up quickly as borrowers’ deposits reduce. And they tend to increase faster as the deposit gets smaller (i.e., as the LVR gets larger) as shown in the following chart.
(based on Helia’s LMI fee estimator)
LMI premiums capitalised onto loans
Consider our first-home buyer again with a 5% deposit (i.e., borrowing $475,000 to buy a $500,000 property). Their monthly mortgage repayments would be $2,848 (using the Australian government’s money smart calculator as at July 2024, assuming a 6% p.a. interest rate, a 30-year loan term and no monthly fees).
That’s $1,025,280 over the life of the loan.
If we capitalise (i.e., add on) the estimated cost of the LMI premium ($15,000) to the loan amount so that we borrow $490,000 in total, the monthly mortgage repayments increase to $2,938. That’s $1,057,680 over the life of the loan.
The total cost of the $15,000 LMI premium, therefore, translates to $32,400 (i.e., $1,057,680 – $1,025,280) after accounting for interest costs over the life of the loan. That’s over double the original premium amount.
This is summarised in the table below:
| Mortgage Metrics for 95% LVR | Without LMI ($) | With LMI Capitalised ($) |
|---|---|---|
| Mortgage amount (est. LMI $15k) | 475,000 | 490,000 |
| Monthly repayments (6% p.a., principal and interest) | 2,848 | 2,938 |
| Total repayments (over life of loan) | 1,025,280 | 1,057,680 |
| Difference (due to LMI capitalised premium) | – | 32,400 |
(Assuming $500,000 property value, 5% deposit, 6% p.a. interest rate, 30-year term & no monthly fees. Source: moneysmart.gov.au/home-loans/mortgage-calculator, accessed Jul 24)
The costs of capitalising LMI, therefore, clearly add up.
LMI isn’t a no-brainer
If you’re a borrower considering LMI, the question to ask yourself is: Should I save for a bit longer and build a larger deposit to avoid a large LMI premium?
There’s no clear answer, of course, as it depends on a range of factors. But if you had perfect foresight, you would (logically) only pay for LMI if its (total) costs are more than compensated by purchasing your property earlier.
Consider a scenario where the type of property you want to buy is in a market where prices are rising. Using our example, if you needed, say, an additional year to save for a deposit (avoiding LMI), then this delay is only worthwhile if your prospective property increases by more than $15,000 over that year.
If your property is in a flat or falling market, you’re better off waiting a year to save for your deposit and avoid LMI.
This is further complicated by the additional interest costs that you’ll incur if you capitalise the LMI premium onto your mortgage.
Waiting a year may also mean paying rent for that year vs. incurring mortgage payments over the year (if you purchased sooner using LMI), so your individual circumstances matter.
Although you can’t predict the future with certainty and there are a number of factors to consider, purchasing LMI clearly isn’t a no-brainer. There are circumstances where you’re better off avoiding it.
Generally speaking, unless you’re confident that the property in which you’re interested will increase by at least the cost of the LMI premium (and possibly more, given capitalised interest costs) over the time it takes to save for a deposit, you’ll be better off waiting (and saving) to avoid the LMI.
Conclusion
Lender’s Mortgage Insurance (LMI) provides a practical pathway for many first-home buyers to enter the property market sooner, overcoming the barrier of a 20% deposit requirement.
But while it helps people to own a home sooner, especially in rising markets, LMI comes at a cost. When you factor in the additional interest payable on capitalised LMI premiums over the life of a loan, these costs can be significant.
Borrowers should carefully weigh the costs of LMI against the potential benefits rather than treat purchasing LMI as a no-brainer.
They should consider factors like market trends in the area of their prospective property, interest rates, financial goals, personal circumstances and the time needed to save for a deposit.
For those willing to pay the premium, the key is to be confident that the benefits of early entry into the property market outweigh the total costs incurred. This isn’t always easy to assess, but being aware of the trade-offs and thinking through priorities will nearly always be a fruitful exercise.