With so many factors to consider when taking out a home loan, it’s not uncommon for people to confuse lenders mortgage insurance (LMI) with mortgage protection insurance.

Where mortgage protection insurance protects you – the borrower – in the event circumstances prevent you from being able to repay your loan, such as an accident, illness or unemployment, lenders mortgage insurance protects the lender. Here’s everything you need to know about LMI.

Why does LMI exist?

A mortgage is usually the largest sum of money a person will borrow and when a lender agrees to loan that money, there is a risk that the customer will be unable to pay the loan back. Although the property that is purchased is used as security, if we see a downturn in the property market that security may not be enough to cover what’s owing on the home loan when the lender sells it.

When does a customer need LMI?

If a buyer has to borrow more than 80 per cent of the property purchase price, they’ll be required to pay lenders mortgage insurance.

Lenders require a 20 per cent deposit from buyers as a guard against the risk of the property being sold at a price less than the loan amount in the event of foreclosure.

By introducing LMI, lenders can pass on this risk to an insurance company. This in turn means that lenders can accept a smaller deposit and means that more people can achieve their property goals.

How does it work?

Lenders mortgage insurance is taken out by banks, building societies, credit unions and non-banks lenders – basically any institution that offers home loans. The insurance providers are heavily regulated to make sure that they hold enough money in reserve to pay all likely claims. The LMI policy sits with the lending institution and the premium is passed on to borrowers who can not make a 20 per cent deposit.

What does it cost? 

In most cases – and unlike traditional insurance policies – lenders mortgage insurance is a one off payment that covers the entire term of the loan. Customers usually have the option to add the premium to the balance of their home loan.

The cost is determined by factors such as how much money is borrowed and the size of the deposit. GST is payable on lenders mortgage insurance and is included in the total cost.

How to apply for LMI

You don’t apply for lenders mortgage insurance – it will be determined in the loan approval process whether or not a borrower needs to pay LMI. First of all, it’s important to ensure a customer can afford the loan repayments and once the loan is approved, all documentation and information on LMI will be provided to the borrower.