Glossary: What is LMI?

This article is part of our Glossary Series, helping you understand some of the many acronyms you may have come across within the mortgage industry. If you come across a term you don’t understand, get in touch and we will add it to our list of definitions.

Lenders Mortgage Insurance (LMI) is an insurance policy which insures the lenders/banks from potential loss.

When a borrower is wishing to borrow over 80% of the value or purchase price of a property, lenders in Australia must insure the loan with an LMI policy. So, the policy covers the bank but the premium is payable by the borrower.

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EXAMPLE
Client wishes to borrow $450,000 to purchase a $500,000 home.
This means the Loan to Valuation Ratio (LVR) is 90%.
The loan is over 80% of the value.
Therefore the bank must insure this loan with the LMI policy.

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There are two ways to pay the LMI premium:

1. Borrowers can pay the LMI premium as part of their contribution to the purchase; OR

2. More commonly, you can CAPITALISE the LMI premium.

Capitalising LMI premium means that in the scenario above where the client is borrowing $450,000 to purchase a $500,000 property, the LMI can also be borrowed.

For example, the LMI premium might be $10,000, so the resultant loan would be $460,000, where $450,000 will be made available for the purpose of purchasing the property, and $10,000 will be paid to the Mortgage insurer.

The downside of mortgage insurance is that it is a once-off fee and it can be expensive, the upside is that it allows home buyers to purchase with less deposit, without having to rely on the Bank of Mum and Dad to help out with savings, or use equity from their home. For investors, the return on investment can be improved given that less cash is being contributed to the investment property purchase.

You may also hear different terms in the marketplace like Risk Fee, or Loan Protection Fee. These are essentially the same thing; however they are structured differently in the background. They essentially serve the same purpose.

RELATED READING: How to avoid paying LMI

If you would like to clarify any other lending jargon, click here to book a call with Stuart Bayliss