Lender’s mortgage insurance (LMI) is a quicker way of getting your hands on a property but going along with it could spell bad news in the long run if you fall into a particularly nasty trap.
For investors who do not have enough money for a 20 per cent deposit, LMI may seem like an attractive option, where the bank takes out insurance on the value of the property.
Essentially, LMI is a case-by-case scenario, but if you do not have enough for the 20 per cent deposit, if the value falls, you decide you do not want the property, it sells for less and the loan is larger than the sale amount, the bank can recoup the loss of funds through you.
Speaking at a panel hosted by financial planner Fox & Hare Financial Advice, buyer’s agent Kellie Landrey said that she recommended to her clients to go in with a full 20 per cent deposit as LMI can take up a considerable amount of savings.
“On a $600,000 property, it could be [$15,000] LMI. That’s a big chunk of your savings that you’re paying towards insurance that doesn’t go to the value or your capital investment in the property,” Ms Landrey said.
“So ideally, if you can save it, it’s ideal, but if it helps you get in the market, there’s other arguments to say … if the property prices are going to go up over the course of the three years, it takes you to save that extra 10 per cent, then you’re potentially going to be winning because you’re going to be buying in at this point of time as opposed to three years’ time.”
Glen Hare, co-founder of Fox & Hare Financial Advice, warned investors to not fall for the misconception that LMI protects borrowers.
“There’s often a misconception around [LMI] that it’s insurance for the borrower. It’s not. It’s for the bank, so you’re paying the insurance premium for the bank, so their position is secured,” Mr Hare said.
However, for investors that believe a property is well and truly worth the risk, LMI can be a helpful way of getting that perfect property.
“Property is a really great way for forced savings, I think, and [LMI] is, it can be really expensive, but it’s definitely worth looking at ... if it helps you get into the market to start growing your wealth,” he said.
“It’s a hard part, I mean, ideally you want the 20 per cent, …but if the numbers add up and you feel the property is a good investment, and you’ve looked at every different scenario, your tax, your cash flow, everything, then it’s just something else to consider.”
One trick that banks can play on investors is to lend more money to cover LMI itself, which as Mr Hare points out, covers the bank one way or the other, but there’s a hidden side effect to be wary of.
“If you do go down the path of increasing your loan to pay for their insurance, you’re obviously also paying interest for the loan for their insurance,” Mr Hare warned.
In order to avoid LMI entirely, investors can rely on a guarantor, like a parent, to pay the deposit on your behalf, but doing so impacts on your cash flow situation, because any income from rent to pay off the mortgage would, depending on the agreement, also have to go to the guarantor and, as Ms Landrey pointed out, you will end up being 100 per cent geared in terms of borrowing.
As a result, if the rental income is not high enough, your profitability on the property could be minimal to not at all.