Lenders mortgage insurance an unwelcome slug
Lenders mortgage insurance (LMI) isn't cheap even though default rates in Australia are low.
According to the latest Fitch Ratings report on residential loan defaults, "mortgage performance is stable" with delinquency rates of 30-plus days sitting at 1.22% in the second quarter of 2014.
The report shows just 34 LMI claims totalling $1.6 million in the second quarter of 2014, compared with 77 totalling $6 million in the first quarter.
The significant decrease in the number of claims and the average claim amount is a result of the appreciating housing market.
Home buyers generally pay LMI when they borrow more than 80% of the value of the property (the loan to valuation ratio, or LVR).
I understand why we need it - it allows lenders to offer higher LVRs while still theoretically protecting the economy in case of a large-scale property downturn.
But does it have to cost so much? With just two underwriters in Australia, I suspect we could do with some competition.
A deposit of $68,000 for a $600,000 property would attract an LMI premium of around $11,000. Depending on which state or territory you live in, stamp duty would also apply. In NSW, for example, stamp duty on LMI is 9.658% of the premium.
As I said, LMI is not cheap. While you can't avoid it you can certainly save some serious dollars because premiums are calculated differently from lender to lender.
Assuming all things are equal, you could in theory get two very different LMI quotes - and that's even if the lenders choose the same mortgage insurer.
Interestingly, economies of scale play no role, according to Smartline adviser Karen Forbes. "The bigger the bank, the more expensive the premium. The smaller the lender, the better the premium."
The challenge for home buyers is to find a good balance between the cost of LMI and the cost of the home loan. "An extra $4000 in LMI premiums requires an exceptional good rate to balance out the cost," says Forbes.
"The interest rate might be low but when borrowers see that there's an extra $3000 or $4000 in premiums added to their loan and their interest repayments - because they pay interest on the borrowed LMI premium as well - that can change their thinking."
Lenders can also charge a higher interest rate - from 0.1%-0.5 % or more - if the loan has mortgage insurance.
So how is LMI calculated and how do you save on something that you have no control over?
LMI protects the lender, not you, the borrower, if you default on your loan.
Loss of principal, unpaid interest and all reasonable recovery costs such as legal fees, marketing costs, repairs, maintenance and outstanding rates are covered by LMI.
While this is comforting for your lender, be aware that the insurer can then go after you for this shortfall.
Exactly how LMI is calculated is not clear. Forbes says it depends on the property, where it's located, your application, whether you're self-employed or employed, if it's an investment, the bank's portfolio of loans and so on.
While there are LMI online calculators, the exact cost is not determined until your lender processes the information. What is known is that lenders use scales to calculate the premium.
One lender's scale, for example, will have a set premium for loans up to $300,000, a higher premium for loans between $300,000 and $600,000, then $600,000-$1million, and so on.
But it varies between lenders, and if a loan is nudged up the scale the premium can go up substantially.
"Some lenders' scales go up in one or two percentage increments, one of the major banks adds a loading for self-employed people, and most lenders have a loading for investment properties," says Forbes.
"This information isn't published on lenders' websites, so you don't know the premium until you're well and truly advanced in the home loan application process."
Forbes says Smartline might recommend a specific product if the LVR is 79% but if it goes up to 81%, for example, "we may have to look at a different product with a different lender in order to best meet the client's needs".
The best tip if you are borrowing over 80% is to ask a few lenders how they calculate LMI so you can compare. Alternatively, enlist the help of a broker to help you choose a loan that has both a low rate and a favourable premium.
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