We receive a lot of questions in regards to LMI so thought I’d share the latest entry from our blog. See below.
In general, if you are borrowing more than 80% of the value of a property you may be required to pay Lenders Mortgage Insurance (LMI).
LMI is an insurance that protects the lender in the event that you default on your mortgage.
The cost of the LMI premium is dependent on how much you need to borrow (for instance it’s higher on a 95% loan compared to an 85% loan) and the value of the loan.
Is LMI a bad thing? While no one likes to pay for an insurance that protects the bank, LMI doesn’t necessarily have to be viewed as a bad thing. In fact, we believe it can be a handy tool for leveraging in the world of property investing.
Here are some reasons:
1. LMI allows you to purchase your own home quicker
Saving a 20% deposit for a house is no easy feat. It can take many years and if property prices are on the increase – you may find that once you’ve saved that 20% deposit, the price of the property you’ve been saving for has increased, meaning you need to keep saving.
With LMI, you can have as little as a 5% deposit. Sure you’ll have to pay LMI – but in a lot of cases, it can be added to the loan (meaning you don’t have to part with your own cash).
In this instance, you’re able to get the keys to your house sooner and you might also be able to enjoy any increased capital growth that the property may experience in the short-term.
2. Helps you to grow your portfolio quicker
Just as LMI can assist with owning your own home sooner, it can also assist with growing your investment property portfolio quicker. Let’s look at an example. Let’s say Jane and Bob have $55k and want to purchase an investment property.
Option 1: Purchase one property without LMI
The property that Jane and Bob are looking at is worth $200k. If they wanted to avoid paying the LMI premium, they would need to put $40k towards the deal (20% deposit) plus enough funds for purchasing costs (stamp duty, legal fees, etc) – which would be about $8k. All up, it’s about $48k in total that the couple will need in order to avoid paying LMI.
Option 2: Purchase three properties with LMI
However, if Jane and Bob decided to pay some LMI they could potentially stretch their deposit over multiple properties. Let’s say the couple decided to buy three $200k properties using a 5% deposit on each. So for each property, they need to put $10k towards the deal (5% deposit) plus enough for purchasing costs (around $8k) – so $18k in total for each property or $54k in total.
With option 2, the couple now have three investment properties which are potentially growing in value. In 10 years’ time, the LMI premium that they paid on the three investment properties will hopefully be insignificant in comparison to the capital growth that the three properties have experienced.
In this example, Jane and Bob have used LMI as a leveraging tool to purchase multiple properties.
This strategy doesn’t work for everyone and is dependent upon your own risk tolerance levels. Someone with a low tolerance to risk might prefer option 1 while a more aggressive investor who’s looking to build their portfolio quickly may opt for option 2.
It’s also important to note that with option 1, the couple effectively own 20% of the property so a small decrease in the value of the property should see them remain in the black. However, with option 2, because the LMI has been added to the 95% loan – the couple only own a small portion of each property. Therefore, a small decrease in the property values will quickly see them in the red. That’s why it’s important that option 2 is seen as a long-term strategy.
Please note – this is a very simplistic explanation purely for the purpose of explaining how LMI can be used to purchase more with less.
3. LMI can be added to the loan
As mentioned above. LMI doesn’t need to be paid out of your own savings. Most lenders will allow it to be added to the loan.
4. Can be claimed back over 5 years
If the LMI is for an investment loan, it becomes a deductible expense that can be claimed back over 5 years.
So that’s it – they’re some of the reasons why LMI doesn’t necessarily have to be viewed as a bad thing.
Other blog entries are available on our site – http://www.passgo.com.au/blog
JamieRichard TaylorParticipant@qlds007Join Date: 2003Post Count: 12,024
Jamie excellent post and totally agree with you.
Small addition "a deductible expense that can be claimed back over 5 years." or the Term of the loan whichever is shorter.
If you take out a 3 year interest only loan then the LMI is claimed over 3 Years.
Yours in Finance
Richard Taylor | Australia's leading private lenderfredo_4305Participant@fredo_4305Join Date: 2009Post Count: 336
Hi Richard thanks for those comments, of which I was unaware regarding the life of the loan comment. In saying that if I refinance that loan with the same lender to access equity after the the 3 years would that mean I need to pay complete LMI again as opposed to a top up?
BrendonScottsdaleParticipant@scottsdaleJoin Date: 2011Post Count: 63
Cheers for the post Jamie. Thought it would have received more response considering LMI can be a great tool for increasing your portfolio numbers.
Would you recommend utilizing LMI as a basis for a beginners property investing strategy? When I first read about it it sounded like a great way to quickly increase the number of properties you can buy and as long as there’s enough of a cash buffer to ensure the loan isn’t defaulted at any time.
Is there an industry standard for the cost of LMI or does it differ from bank to bank and their perceived level of the applicants risk? I’ve only seen $6k/year being mentioned as a cost and this seems like a pretty small (tax deductible) expense considering you could be receiving capital growth from 2 properties instead of 1.
DerekRichard TaylorParticipant@qlds007Join Date: 2003Post Count: 12,024
Yes LMI premiums vary from Insurer to Insurer and even from Bank to Bank using the same mortgage insurer.
It is a sliding calculation based on the loan amount and lvr and is a single one off premium.
In my opinion it is definately worth considering if it gets you up the property rung that much quicker.
Yours in Finance
Richard Taylor | Australia's leading private lender
No worries at all. It's a topic that frequently comes up with my clients so thought I'd share my thoughts.
Would I recommend it? It depends on the individual and their tolerance to risk. Personally, I think that those starting out (who have minimal equity/savings) could benefit the most from taking out higher LVR loans and adding the LMI on top. It's once you have some equity under your belt that you can start to take out 80% loans and avoid LMI.
The LMI premium will change from bank to bank but is generally linked to the LVR and the value of the loan.
My wife and I used LMI to kick start our portfolio – you can read about our story in the May 2011 edition of Australian Property Investor magazine.
JamiebjsaustParticipant@bjsaustJoin Date: 2009Post Count: 141
Also, LMI can reduce risk. Every time I've purchased (other than through SMSF) I've used LMI and got a bit extra as well. If you have a 100% offset or similar, you can park that extra in the account, so your interest is no more than it would have been if you didn't, but you now have a built in buffer in case of emergencies.ScottsdaleParticipant@scottsdaleJoin Date: 2011Post Count: 63
bjsaust, that's a very smart idea alright. Will be implementing it when I start buying as I'm sure it's great to have that 'piece of mind' in the offset. Would you ever use the money for another IP deposit instead or do you prefer a buffer being in place for every property? And if you don't mind me asking, how much do you usually set aside?
Jamie, pulled out the May edition to look for your article… a lot of it had been highlighted! Your strategy of buying below market value, doing a small reno and then using the newly created equity to invest elsewhere is exactly what I intend to do. That approach plus using LMI would defintitely help increase the numbers, especially as I'm looking to scale the property rungs very quickly but, of course, equally as cautiously
DerekDloy wrote:Jamie, pulled out the May edition to look for your article… a lot of it had been highlighted!
That's awesome news! I'm glad you were able to get something out of the article. I'm a strong believer in value adding – it doesn't take much to add some equity and it sure beats waiting around for the value to increase itself.
Best of luck with the investing
JamieThe ImmigrantMember@the-immigrantJoin Date: 2008Post Count: 73fredo_4305 wrote:if I refinance that loan with the same lender to access equity after the the 3 years would that mean I need to pay complete LMI again as opposed to a top up? Cheers Brendon
Hi. No one has particularly answered above query. And i am seeking the same answer as well. Say you paid for LMI, and after 2 years your property has increased in value and you want to access that extra equity. Will you have to pay again for an LMI?
Also, if I were to take a construction loan (95% LVR), when will the LMI applicable? once the accumulated loan reaches say 80% LVR? or right from the start?
I appreciate any replies.