Having a 20% deposit is often seen as an ideal benchmark for buying a home – and with good reason. Some banks will accept a far smaller deposit. At Defence Bank, we ask for a minimum deposit of 5% deposit on our home loans.
However, if your deposit is below 20%, it’s likely you’ll be asked to pay lenders mortgage insurance (LMI).
LMI works differently to most other types of insurance. Homebuyers pay the LMI premium, but the insurance protects the lender – not the home buyer. It’s designed to compensate the bank if borrowers can’t keep up their home loan repayments.
LMI is not the same as mortgage protection insurance, which helps homeowners manage their mortgage repayments in the event of death, illness or unemployment.
Adding to upfront costs.
Homebuyers don’t need to shop around for LMI. Your bank will sort LMI for you, explaining how much you need to pay. Defence Bank’s lenders mortgage insurance provider is Genworth Financial Mortgage Pty Limited ABN 60 106 974 305. For more information on lenders mortgage insurance refer to Genworth’s LMI Fact Sheet.
Unlike other types of insurance, you only pay one LMI premium at the start of your loan. It doesn’t need to be renewed annually.
Use the Genworth premium estimator to give you an indication of the LMI premium payable.
How LMI can work in your favour.
The upside of LMI is that it allows home buyers to get into the market sooner. When property values are rising, the cost of LMI can be far less than the extra you may need to pay for a home if you wait until you’ve saved a 20% deposit.
As a guide, let’s say Sue has built up a deposit of $50,000 over two years. She wants to buy an apartment costing $500,000. Her savings are worth 10% of the property’s price, so she is likely to pay LMI. The premium could be around $8,700.
Sue can avoid this cost by saving an additional $50,000. This would take her deposit to 20%, but it will take Sue another two years to save this much. If property values rise by 5% annually, by the time Sue has grown her deposit to $100,000, the apartment would be worth $551,250. Her $100,000 deposit would be 18% of the property’s value. So she still wouldn’t have the 20% deposit needed to avoid LMI.
On the flip side, if Sue had paid the LMI of $8,700 to buy the property for $500,000, her home would have climbed in value to $551,250 two years later. This would mean Sue is at least $42,550 better off, even after allowing for the cost of LMI.
The drawback of LMI.
The catch with LMI is that it will add to the upfront costs of buying a home. How much LMI you pay depends largely on the property’s value and the size of your deposit. As a general rule, the lower your deposit, the higher the LMI premium is likely to be. Nonetheless, as we saw with Sue’s example above, the LMI premium can run into thousands of dollars.
Some banks let you ‘capitalise’ LMI, meaning you add the premium to your home loan and pay it off over time. However, this will mean paying interest on the premium, which pushes up the long term cost.
Minimising the cost of LMI.
Opting for a more affordable home can help you minimise or avoid LMI altogether.
Or, if you’re a first home buyer, you may be eligible for the First Home Loan Deposit Scheme (FHLDS), which lets you buy with as little as 5% deposit. No LMI applies as the federal government acts as a guarantor for the remaining 15% you’d need to make up a 20% deposit.
Defence Bank is an approved lender for the FHLDS. So if you’re a first home buyer, we can explain if you could be eligible.
Important note: This information is of a general nature and is not intended to be relied on by you as advice in any particular matter. You should contact us at Defence Bank to discuss how this information may apply to your circumstances.