You’ve decided to become first home buyer. It’s an exciting time, but it can also be a bit overwhelming, especially when it comes to financing. One term you might encounter that raises eyebrows is Lenders Mortgage Insurance, or LMI. Don’t let the fancy term scare you – we’re here to break it down into easy-to-understand bits.
What is LMI and Why Does it Exist?
Imagine you’re a lender and someone comes to you wanting a mortgage, but they only have a 15% down payment for a house. That means the borrower is financing 85% of the home’s value. While you’d love to help them achieve their dream of homeownership, there’s a higher risk that they might not be able to repay the entire loan if something goes wrong.
That’s where LMI steps in. It’s basically an insurance policy that protects the lender in case the borrower defaults on the mortgage and the house ends up being sold for less than what’s owed. So, if you can’t keep up with your payments, LMI kicks in and covers the difference for the lender.
The Cost of Safety: How Much Does LMI Cost?
There’s no free lunch, and LMI is no exception. The cost is typically borne by the borrower and can range from 1% to 5% of the total loan amount. The exact percentage depends on a few factors:
- Loan-to-Value Ratio (LTV): This is the percentage of the property’s value that you’re financing. The higher your LTV (meaning the lower your down payment), the higher the LMI cost.
- Property Value: The value of the house you’re buying also plays a role. Generally, LMI costs more for expensive properties.
- Loan Type: Some loan types, like investment property loans, may have higher LMI premiums compared to owner-occupied loans.
Here’s a quick example to illustrate the cost:
Let’s say you’re buying a house for $500,000 and putting down a 15% down payment ($75,000). This means you’re borrowing $425,000 (loan amount). If your LMI rate is 2%, you’ll pay an upfront premium of $8,500 (2% of $425,000). This amount can be added to your loan or paid upfront, depending on your lender and your preference.
Should You Pay LMI or Save for a Bigger Down Payment?
This is a question every homebuyer with a smaller down payment grapples with. Here’s a breakdown of the pros and cons to help you decide:
Benefits of Paying LMI:
- Get into the Market Sooner: You don’t have to wait years to save up a 20% down payment. You can enter the housing market and start building equity in your own home.
- Avoid Rising Prices: In a hot housing market, property values might increase faster than you can save. By paying LMI, you can lock in a lower purchase price today.
Drawbacks of Paying LMI:
- Higher Overall Loan Cost: LMI adds to the total cost of your mortgage. You’ll be paying interest on both the loan amount and the LMI premium.
- Limited Loan Options: Some lenders might have stricter requirements or offer less favorable loan terms for borrowers with LMI.
Benefits of Saving for a Bigger Down Payment:
- No LMI Cost: You save thousands of dollars by avoiding the LMI premium.
- Lower Monthly Payments: With a larger down payment, you’ll borrow less, leading to lower monthly mortgage payments.
- More Loan Options: You’ll qualify for a wider range of loan options with potentially better interest rates.
Drawbacks of Saving for a Bigger Down Payment:
- Longer Wait: It can take time to save up a 20% down payment, especially in expensive housing markets.
- Missing Out on Market Opportunities: While you’re saving, property prices might rise, making it harder to afford your dream home.
The Bottom Line:
The decision of whether to pay LMI or save for a bigger down payment depends on your individual circumstances. If you’re eager to get into the housing market and are comfortable with a slightly higher monthly payment, LMI might be a good option. However, if you’re patient and can save more upfront, you can save a significant amount of money in the long run by avoiding LMI altogether.
