Understanding LMI

LMI is a specialist commercial insurance that a lender buys to insure itself against the risk of not recovering the full loan balance if a borrower defaults on their home loan repayments, and the proceeds from the sale of the property are not sufficient to repay the outstanding loan balance.

Although LMI protects the lender, LMI also provides borrowers with important benefits. LMI enables borrowers to break the rental cycle and access home loans sooner even when they don’t have the required deposit, typically 20% of the purchase price. LMI can also help borrowers looking to upsize or refinance their home loan. Borrowers will need to meet the lending requirements of their chosen lender.

LMI insurance doesn’t protect the borrower. It protects the lender from loss on a mortgage in the event the property is sold, and the lender is unable to recover the outstanding loan balance.

In these circumstances, when a property is sold and there is a shortfall between the outstanding loan balance and the proceeds from the sale of the property, the lender will claim this shortfall from QBE LMI. QBE LMI will pay this to the lender in accordance with the LMI agreement.

Borrowers have access to a range of other insurance products designed to protect their ability to repay their home loan when they experience things like loss of employment or sickness. Borrowers should discuss these products with their financial institution.

LMI is typically purchased by a lender when a borrower, who is otherwise credit worthy, has not saved a substantial deposit (typically 20% of the value of the residential property). Due to the small deposit, the amount borrowed is high compared to the value of the property. These are known as high loan to value ratio (LVR) loans. These loans are riskier and capital intensive for lenders.

With the expertise and support of LMI, more lenders are prepared to participate in and compete for residential mortgage lending business, particularly high LVR lending. By using LMI, lenders can pass on this risk to a specialised mortgage insurer, such as QBE LMI. Many lenders would otherwise not have the risk appetite, expertise or capacity in this segment.

Before LMI was available, lenders required borrowers to contribute a large deposit to the purchase of a property. This was to protect the lender in the event of default by the borrower, ensuring that the proceeds from the sale of the property would be adequate to cover the total outstanding debt owed to the lender.

With the ability to use LMI to insure the risk that there might be a shortfall after the sale of the property, lenders have been prepared to lend more, accept a lower deposit and also to offer lower interest rates for mortgages than they would otherwise be able to offer borrowers. As a result, cost effective home loans are available to more people, enabling more people to achieve the dream of home ownership.

The lender will pay the LMI premium to the insurer as a single, up-front premium at the commencement of the policy, which is usually on settlement of the mortgage. LMI provides protection to the lender for the entire life of that loan (which can be up to 30 years). The cost of the LMI premium is usually passed on by the lender to the borrower as a fee. Borrowers can either pay the LMI fee upfront or capitalise this cost into their loan amount. The lender can provide details of the fee options available to borrowers.

LMI premiums are ’community rated’. This means the cost of LMI predominantly depends on the loan size and LVR rather than borrower characteristics, such as employment type, location or credit score. This is an advantage for many borrowers because it increases the accessibility and affordability of home loans. There may be loadings, such as for investment loans or discounts, typically for first homebuyer loans.

It’s important to understand that LMI is very different to mortgage protection insurance, which protects a borrower by making certain mortgage repayments on their behalf or paying off a lump sum of the mortgage in certain circumstances, such as involuntary unemployment, sickness, accident or death.

If the borrower is unable to repay their home loan, the property might need to be sold. Sometimes a borrower may choose to sell the property. Where the money received from the sale of the property isn’t enough to repay the outstanding loan owing to the lender, the lender will claim this shortfall from QBE LMI. QBE LMI will pay this to the lender in accordance with the LMI agreement.

This amount is usually the difference between the outstanding loan balance, the sales costs, and the proceeds from the sale of the property. Once an LMI claim has been paid to the lender, the outstanding shortfall owed by the borrower is typically passed on from the lender to QBE LMI. This means that QBE LMI may then seek to recover the remaining shortfall from the borrower and any guarantors.