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 repayments.
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:
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.
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 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.
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.
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. Chat with an accountant about tax tips though!
So that’s it – they’re some of the reasons why LMI doesn’t necessarily have to be viewed as a bad thing.
If you’d like to have Jamie provide advice on your finance structure, investment strategy, first home purchase, upgrade or refinance simply complete and return this FORM and he will be in touch – this is a FREE, no obligation service.
The information herein is not intended as investment, financial, legal, taxation, building, development or any other advice and must not be relied upon as such. You should obtain independent professional advice and make further independent enquiries before making financial, legal, taxation, building, development or investment decisions.