Two questions frequently asked, are "What is Lenders Mortgage Insurance?" and "Will I need it when Refinancing a Home?" In this article I will explain what Lenders Mortgage Insurance is, how it works and influences you when Home Refinancing.
The function of Lenders Mortgage Insurance (LMI) is to save the home loan lending insttution from incurring a deficit of money in the incident of a borrower defaulting on their mortgage, resulting in foreclosure and a subsequent mortgagee sale. If the proceeds from the mortgagee sale are not enough to pay back the home loan in full, LMI will meet the loss for the mortgage lender.
LMI shouldn't be confused with Mortgage Protection Insurance (MPI), which protects a borrower against their incapacity to repay their loan in the event of an unforeseen circumstance like unemployment, illness or death. MPI covers payment of your home loan instalments and/or your loan balance. CPI insurance is not mandatory and is exclusively the choice of the borrower. The premium for CPI is paid annually and usually varies based on the size of the home loan.
Why is Lenders Mortgage Insurance required?
Lenders including Banks, Building Societies, Credit Unions and non-bank lenders, either use cash from deposits held in savings accounts and term deposits, or borrow funds to provide mortgages to borrowers for home refinancing, purchasing, construction or equity purposes. By using other peoples' cash to fund mortgages, the lending institutions form an obligation to repay that cash to the suppliers of the money while at the same time taking on the risk that they may not receive all or some of the funds back that they loan.
Even though they hold property as security for the home loan, the value of the real estate may decline due to market forces, contagion or damage to the improvements, ending up in the security not having sufficient value to cover the amount of the home loan. To offset their obligations to the suppliers of the mortgage funds, the lending institutions take out LMI to cover any probable loss.
Do I benefit from LMI?
Before LMI was available, lending institutions desired borrowers to possess a deposit of no less than 20% when buying a dwelling or equity of 20% when refinancing a home to minimise the risk of lending and shield them against potential loss in the event of foreclosure. Nowadays with the ability to pass on the risk of loss to an insurance company through LMI, lending institutions are prepared to agree to a lower deposit for purchases and less equity for refinancing a home.
Also, if lenders did not use LMI to mitigate lending losses, then those losses would need to be recouped from the profits of other mortgages, in effect increasing mortgage interest rates. To stay away from this, lending institutions opt to take out LMI and have the insurance provider take on the risk and wear any loss.
By lenders using LMI, the advantage to borrowers is that they are able to purchase a property using a smaller deposit or refinance a house with less equity and/or get lower interest rates than they would otherwise be able to do with no LMI.
Please note, that even though LMI will give some benefits to the mortgagor, it doesn't cover the mortgagor against loss ensuing from foreclosure. LMI ONLY INSURES THE MORTGAGEE as in effect, they are the beneficiary of the insurance policy! In the event of a claim for loss, the lender will collect the proceeds from the LMI claim, not the mortgagor. Any loss ensuing from foreclosure, regardless of LMI, is a loss incurred by the borrower and will remain as such. The only difference being is that the mortgagor's legal responsibility to the finance provider for the loss will move as a legal responsibility to the LMI provider for the loss in the episode of an LMI claim by the lender.
Who pays the LMI Premium?
The LMI provider's contract of insurance is with the lender and the premium is payable by the lender however in certain situations the lender may pass on the cost of the insurance to the borrower as a cost of providing the home loan.
A mortgage where a deposit or equity of less than 20% is permitted means a higher risk to the lending institution, and in this case the lending institution will usually pass the cost of LMI on to the mortgagor as a fee for them being able to get a loan that they would normally not have been able to get.
What is the cost of Lenders Mortgage Insurance and how is it paid?
The premium for LMI is a one off premium due upfront on the day of settlement of the homeloan with payment of the premium being the responsibility of the lending institution. The lending institution will subtract the premium from the home loan proceeds if and when the cost of LMI is to be met by the mortgagor.
The premium cost will differ depending on the amount of the home loan and the ratio of the home loan size to the value of the security i.e. Loan to Value Ratio (LVR). The higher the LVR the more expensive the premium, also the bigger the homeloan amount the more costly the premium.
Are the providers of LMI sound?
LMI providers work under strict government regulation to ensure they maintain adequate liquidity to meet claims, as well as hold adequate funds in reserve, in the event that a large number of claims are made in a short period of time or increase substantially.
How is Lender's Mortgage Insurance arranged?
The granting of LMI is not automatic and has to be applied for by way of application to the LMI provider. Should your home refinancing necessitate LMI, your Mortgage Broker, Planner or Mortgage Consultant in conjunction with the lender, will prepare all the obligatory documentation and present you with all the information about the application procedure.
Provided the borrower, homeloan structure, home refinancing purpose and security property meet with the appropriate LMI provider underwriting guidelines an LMI Certificate of Cover will be issued to the finance provider.
As you can understand, Lenders Mortgage Insurance does offer some benefit to the borrower in the form of lower interest rates however it is chiefly used as a risk mitigation tool by the lender. When refinancing a home the benefit of LMI is greatest when the security property equity is less than 20% as the mortgagor would generally not be able to obtain such a loan. However that increased benefit arrives at a price in the form of increased home refinancing expenses.
So when refinancing a home it is important to preserve as much security property equity as possible, in effect reducing the price tag and/or requirement for LMI and balance the worth being achieved from the home refinance with the price of LMI.
