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LMI: Friend or Foe?

Discussion in 'Property Finance' started by Corey Batt, 16th Nov, 2015.

  1. Corey Batt

    Corey Batt Finance Strategist Business Plus Member

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    Minimising costs is great, we should all do it. Sometimes however in saving as much as possible, we spite our long term potential by focussing too much on the short benefits. LMI is no exception – it can be both a tool and an unnecessary cost, dependent on the situation and how you utilise it with your lending.

    What is LMI?

    Lenders Mortgage Insurance (LMI) is a fee charged by lenders for loans which have <20% deposit or equity at purchase or refinance. LMI protects the lenders in the unfortunate event of the borrower defaulting on their home loan – which is at a higher risk when a lower deposit is used. Keep in mind that LMI is not to protect you, but the lender’s interests – you are still liable for any outstanding debts and repayments.

    LMI is paid at settlement with all other lender and government charges, it can either be paid in cash with the contribution funds, or added to the loan (referred to capitalisation or ‘capping’).

    How does a LMI loan differ from an uninsured loan?

    80% LVR:

    • No LMI charges paid

    • Generally easier to finance – this can mean quicker turnaround times, flexibility with lenders policies (if a property is partially damaged, the insurer may not allow the purchase, but without LMI it would be possible), potentially no valuations required

    LMI (80.01%-99% LVR)

    • LMI applicable – a one off fee charged on the loan at establishment, generally can be added to the loan so long as the LVR’s are maintained

    • Dependent on the lender and Loan to value ratio (LVR), the mortgage insurer (QBE, Genworth etc) may need to approve your loan as well as the lender – meaning you can potentially be declined on a loan that the lender is happy to offer

    • LMI rates are scaled – the higher the LVR, the higher the rate of LMI is charged, likewise the higher the loan value, the higher the charge. As such a high LVR loan with a large loan amount can result in an extremely large LMI charge.

    Which is best for me?

    This really depends on the specific scenario of each borrower. The primary consideration is in weighing up the cost of the charge, versus the opportunity cost of adding additional funds into a purchase. If a borrower has substantial enough equity base where they can make their planned long term purchases with 20% deposits, then it may be an unnecessary cost.

    However, if like most investors, the borrower is reliant on future savings and equity to continue to grow their portfolio, waiting for a 20% deposit before each purchase will significantly extend the time required for each purchase, pushing out the investment horizon for each investment and the eventual investment goals. In these cases it can be useful to utilise LMI as a tool to shorten the time between each purchase, gaining more exposure into the market sooner.

    Useful tips to make the most of LMI

    There are a few little useful tips which can help you minimise your LMI costs through using specific LVR’s and by careful forward planning to ensure you do not pay any excessive charges from unnecessary refinances.

    The Sweet Spot

    As previously mentioned, LMI is calculated as a multiplier against both the loan value and the loan LVR. As the LVR and loan amount increases, the multiplier increases exponentially. There is a point where you can minimise your deposit amount, but before the LMI charge rate rapidly increases – which is at 88% LVR (and allowing capitalising of the LMI, up to a maximum LVR of 90%). By keeping to this level, you can reduce your deposit requirements to 12%. Here’s an example of the subtle differences which cause significant savings:

    Scenario 1 – 88% LVR + LMI

    Purchase Price: $500,000

    Loan Amount: $440,000

    LVR: 88%

    LMI Charge: $5,755

    Scenario 2 – 90% LVR + LMI

    Purchase Price: $500,000

    Loan Amount: $450,000

    LVR: 90%

    LMI Charge: $9,911

    In this one scenario, if the purchaser increased their deposit by 2%, it would result in a saving of $4,156, or 41% saving on the increased deposit amount.

    Increasing Accessible Equity

    By utilising LMI within reason as above, you can also tap into your existing properties to dramatically increase the deposit funds available for expanding your portfolio. Any LMI paid at purchase isn’t dead money, as it can then be used as a credit towards equity releases – meaning you can potentially release equity up to 90% with little or no LMI charged.

    Likewise it’s possible to continually release equity at a declining LVR, to have each new LMI amount match the previous amount paid – effectively charging $0 LMI for each top-up, as you continually reduce your effective LVR until reaching 80%.

    Exemptions

    As of late there have been a small handful of lenders offering 85% LVR with no LMI as a promotion, this has been a temporary offer which has been a marginal saving for a lot of customers – however it cannot be relied upon to be offered indefinitely.

    Likewise a number of lenders allow customers within certain industries which meet set criteria (income levels, industry membership) access to lending up to 90% LVR with no LMI charge. Industry professions can include lawyers, accountants, engineers, doctors etc.

    Conclusions

    Both a cost and a tool, LMI is an important consideration for all people looking to purchase property. LMI can be useful if used correctly and in a measured way. By strategically using specific LVR’s you can contain costs and open up options to rapidly grow your portfolio - compared to sitting out of the market saving more funds/waiting for equity growth.
     
    Last edited: 16th Nov, 2015
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  2. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    Good piece

    Id call LMI an investment rather than a cost per se

    Difference being that with cost or expense you generally dont expect a return.

    With LMI is used appropriately and a rising market can provide for a large return on the investment, because as you say it provides more rope, sooner.

    ta

    rolf
     
  3. meme plecko

    meme plecko Well-Known Member

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    You can also recover a good part of LMI back as it is tax deductible over 5 years, right?
     
  4. Jamie Moore

    Jamie Moore MORTGAGE BROKER - AUSTRALIA WIDE Business Member

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    Yep - that's right.

    Cheers

    Jamie
     
  5. Tekoz

    Tekoz Well-Known Member

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    LMI is bad for Owner Occupier for staying in the property longer than 5 years, but it is good for investing or even Owner Occupier under 5 years period.

    is that correct @Jamie Moore ?
     
  6. Corey Batt

    Corey Batt Finance Strategist Business Plus Member

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    The assumption in this argument is that there will be no growth in the property prices during the time required to save additional funds. For example - you wouldn't want to wait a further 12 months to save a sufficient deposit (lets say 20k), only to have prices rise 40k for the example property during the time same.

    More often than not, I've found it's always been a case of getting in while you can, and working from there. The exception to the rule is mainly when going above 90% LVR, where the costs dramatically increase to the point where it's a gamble either way.
     
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  7. Tekoz

    Tekoz Well-Known Member

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    Ah Cool, now I understand more about it.
    So what is the sweet spot or the magic number for LMI @Jamie Moore I'm thinking of 88% maximum for the once off LVR premium, because above that rate it is quite expensive.
     
  8. pinkboy

    pinkboy Well-Known Member Premium Member

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    As explained in the original post......................

    pinkboy
     
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  9. Redom

    Redom Mortgage Broker Business Member

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    Great write up Corey. Appreciated. :)

    Probably worth noting on this thread that re-releasing equity above 80% isn't as easy as purchasing above 80% with some lenders. That is, its worth inputting a higher probability of not being able to rerelease equity above 80% given the uncertainty cost. Sub 80% equity releases are still relatively simple with many lenders (CBA, ANZ, NAB up to 100k, Dragon, BoM, etc). Above 80%, it can cause headaches and financing uncertainty with lenders often looking to say no instead of yes. Also an area that may be subject to policy change over time.
     
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  10. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    And incurring LMI on an increase is not so straight forward from a tax point of view.
     
  11. MTR

    MTR Well-Known Member Premium Member

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    When I was using lo doc/no docs some years ago now, it was just part of business, pay the LMI, never gave it a second thought. I recall paying $10K with one deal, seems a lot of money, but if your profits are 10 fold, then its peanuts.

    MTR:)
     
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  12. Michael_X

    Michael_X Mortgage Broker Business Member

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    Excellent piece, great write up Corey!

    To add, 80% also allows valuation shopping which can be important for renovation strategies or any strategy where the valuation is key to it's success.

    Cheers,
    Michael
     
  13. mcarthur

    mcarthur Well-Known Member

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    Great Corey.
    Perhaps add that one disadvantage with LMI in that there's no current portability between lenders. So if there's any chance or need to change lenders for the life of the loan, it means you effectively "lose" the paid LMI (either as cash or capitalised as part of the loan). You may even need to pay the LMI again for the new lender.
    It's another reason why changing lenders should be carefully decided upon.
     
  14. jpcashflow

    jpcashflow Well-Known Member Business Member

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    Every one is different but for me any investments that I purchase I generally only borrow up to 80%.
    I prefer to have a buffer in place.
     
  15. D.T.

    D.T. Adelaide Property Manager Business Member

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    I equate higher lvr to having a buffer, because then I get to keep more of my funds to use if something goes wrong
     
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  16. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    Thats the banks buffer not the borrowers..............

    Its not accessible without a refi ( in most cases)

    ta
    rolf
     
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  17. melbournian

    melbournian Well-Known Member

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    Which industries are included into this? i have never used LMI before but say if one had 700-900K in cash, what would be best approach to purchasing say another 2-3 properties. 80% on all purchases or LMI if one wanted to purchase more?
     
  18. Barny

    Barny Well-Known Member

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    If you have used a high lvr, and paid for Lmi with your particular lender, and later decide you would like to renegotiate a better interest rate whilst still at the same high lvr when starting the loan..
    Would you incure new charges for the lmi again, is it considered a new loan?
     
  19. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    usually not.........but shifting lenders will usually require a new LMI premium if the lvr is still above 80 %

    some lenders do have higher rates for > 80 %

    ta
    rolf
     
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  20. Azazel

    Azazel Well-Known Member

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    Good stuff Corey.
    Is there any little things to keep in mind regarding drawing equity during the 5 years that LMI is deductible?