LMI insures the lender, NOT the borrower. The insurance covers the lender of any shortfall should the borrower default on the mortgage repayments and the property can end up being sold for less than the outstanding loan balance plus some costs. Do not confuse LMI as a ‘Mortgage Protection Insurance’, which covers your repayments should you die, lose your job or become incapacitated.
The borrower must realise that it is the borrower who is paying for the insurance policy, even though it is the lender who benefits. Borrowers pay the premium for the insurance up-front either from cash deposit funds or more commonly, by adding or ‘capitalising’ it into the loan, meaning it can be payed off as part of normal mortgage repayments.
It is really important to understand the real lack of cash flow implications an LMI can have on an investment loan. As the LMI is usually capitalised against the new investment loan then even a $10,000 LMI at an interest rate of 4.5% is only going to add an additional $450 gross per annum on to investment property holding costs. On the top marginal tax rate this would reduce to a $229 per annum net cost. This is just over 6c per day additional cost on a properly negatively geared property investment – hardly a reason to walk away from a property with a great growth potential!
The cost of LMI varies according to deposit size, loan size and type.
As an example: buying a $500,000 property with a $50,000 deposit, resulting in only 10% equity and a loan-to-value ratio (LVR) of 90%, would mean at current rates with a standard loan, the LMI costs could be around $8,000.
