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Aaron Alston

Understanding the Benefits of Lenders Mortgage Insurance (LMI) – Why paying LMI might be the best financial decision you ever make!

Written by Aaron Alston

What often gets overlooked is the significant advantages that come with embracing Lenders Mortgage Insurance (LMI).  In this article, we’ll delve into why viewing LMI as an opportunity rather than a burden can be a game-changer for both clients and financial advisers alike.

Seizing Growth Opportunities

First and foremost, let’s address the opportunity cost associated with delaying entry into the property market by refusing to pay LMI.  Many prospective buyers opt to save a larger deposit (i.e. 20% of the purchase price) to avoid LMI, but in doing so, they often miss out on substantial growth in property values. It’s crucial to emphasize that the growth potential of real estate can far outweigh the cost of LMI. By entering the market sooner with a smaller deposit and utilising LMI, investors can capitalise on this growth potential and start building equity sooner rather than later.

Case Study – John and Mary (both aged 28) earn $150 000 p/a combined income.  Currently, they have no children and have NIL debt.  They have saved $130 000 for a deposit on a home and have set aside $20 000 in emergency funds as a buffer.  John and Mary would like to purchase a nice townhouse in their area for $750 000, however they delay the purchase for 3 years’ time until they have enough savings for a 20% deposit + costs + $20 000 in emergency funds.  They have available surplus of $20 000 p/a to put towards the deposit.  In 3 years’, time and much to John and Mary’s surprise, property prices rise at a quicker rate than their ability to save.  See illustration below.

Start of Year 1 End of Year 3
Property Value $750 000 $850 000
*Purchase costs* $25 000 $30 000
20% deposit $150 000 $170 000
Total deposit required $175 000 $200 000
Available savings for deposit $130 000 $190 000
Have John and Mary saved a 20% deposit + costs NO NO

Note – the purchase costs are an estimate and is based on the cost of stamp duty in QLD only.  Stamp duty varies from state to state.  I have also considered legal fees and bank fees and charges above.

Outcome – Due to rising property values, John and Mary have forgone $100 000 capital growth by refusing to pay LMI and secondly, they haven’t achieved their goal of saving for a 20% deposit.  Had they consulted a financial adviser and mortgage broker and understood the benefits of LMI and capitalised in on the home loan, they would have entered the property market sooner and be in a better financial position.

John and Mary seek financial advice to consider the benefits of LMI

As a prospective homebuyer, John and Mary initially viewed Lenders Mortgage Insurance as an additional expense to avoid. However, after consulting their financial adviser and understanding the broader implications, they realised that LMI presented an opportunity rather than a setback.  By embracing LMI, they can expedite their entry into the property market and capitalise on potential growth opportunities.

Mitigating Risk and Enhancing Flexibility

While growth potential is undoubtedly a significant benefit, it’s essential to recognise the risk mitigation aspect of LMI.  A client can purchase a property with a smaller deposit which means they can reduce their exposure to property market fluctuations. Additionally, LMI provides a level of flexibility, allowing a client to allocate their funds more efficiently across various investment opportunities rather than tying up a large portion of their capital in a single property.

The role of the bank

From the perspective of financial institutions, LMI serves as a risk management tool that enables them to provide loans to a broader range of borrowers. By transferring a portion of the risk to the mortgage insurer, banks can offer loans with lower deposit requirements, thereby increasing accessibility to the property market. It’s important for clients to understand that while they may incur the cost of LMI, it ultimately enables them to secure financing with more favourable terms and interest rates.

The role of a finance broker

At Hudson, our financial advisers and finance team guide clients through the intricacies of LMI and help them understand its value proposition. By illustrating how LMI can facilitate entry into the property market and accelerate wealth accumulation through capital growth, it enables clients to make informed decisions aligned with their financial goals.  There are many things to consider when purchasing a home such as lender, loan structure, interest rate, LMI amount, serviceability, ongoing repayments etc.  It is crucial you seek financial advice.

Conclusion

LMI should be viewed not as a barrier but as a catalyst for achieving financial objectives.  By embracing the growth potential, risk mitigation, and flexibility afforded by LMI, clients can embark on their property ownership journey with confidence and optimism, guided by the expertise of Hudson.

 

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