Buy Now Using LMI or Rent & Save 20%?
When deciding whether to rent and save for your 20%, or whether you’ll buy your property sooner with a smaller deposit, there’s a bit to consider. Firstly, do you have the discipline you'll need to save that extra money? Or would you find it easier to make the 'forced saving' through mortgage payments?
If you want to purchase a property with less than 20% of the purchase price for your deposit, you'll need to pay what's known as Lender's Mortgage Insurance.
The total amount of LMI that you'll pay will depend on how close to that 20% deposit you are, and the purchase price and location of the property you buy.
Who Does Lender’s Mortgage Insurance Protect?
Lender’s Mortgage Insurance (LMI) is a fee that insures the bank if you default on your loan.
Even if you've paid LMI, if you default on your mortgage and your house is sold by the bank, if the sale price doesn’t cover your mortgage you could still be up for the difference.
Mortgage Insurers launch bankruptcy proceedings against homebuyers.
In the past 10 years, Australia’s two major LMI providers, Genworth and QBE LMI have launched bankruptcy proceedings to recover their costs against homebuyers who have defaulted on their mortgages.
This happened because the mortgagees had borrowed more than their property was worth - we call this being ‘highly geared’ - and they had negative equity when they defaulted on the mortgage.
Scott Pape would advise that paying LMI is never a good idea. So how much does is really cost, and is it ever worthwhile to pay LMI to get into a home sooner?
I want to buy ASAP, what will LMI cost?
For example, if you’re buying a property worth $330, 000 you might have saved a $20,000 deposit (5% of the purchase price).
If you want to purchase right away, you’ll need to pay LMI of $11, 088, excluding stamp duty, upfront.
The other alternative is to include your LMI into the amount that you borrow from the bank - assuming that you have an interest rate of 4.45%, this will add an extra $55 per month to your mortgage payments.
This is a cost of $660 per year. Over the life of your mortgage, this will add up to $19, 800.
If you’re wondering exactly how much LMI you’ll pay, you can actually calculate it here on the Genworth website. You can see the difference in the cost of LMI when you have a larger deposit, or if you buy a less expensive property.
What happens to my LMI if I refinance with a different lender?
It depends how much of your home has been paid off by the time that you refinance. If you have 20% equity in your home by the time you refinance, you won't need to pay LMI again. But if you refinance when you have less than 20% equity, you’ll pay LMI all over again on the new mortgage.
When is it better to wait and save 20%?
If you are good at saving and you can knuckle down and wait another couple of years, you’ll ultimately save a lot by having your 20% deposit up front.
Add to this the amount you’ll save on interest with a smaller loan amount, and there’s a pretty nice car or renovations to improve your home right there.
Rental costs are actually falling, giving you the opportunity to save more.
While house prices continue to rise, the cost of renting, according to CoreLogic RP Data, rental costs are actually falling, putting you in a better position to stack money away for your deposit before you commit to mortgage payments.
You may have some fear that as house prices just keep going up, waiting another 2 or 3 years will mean that you’re locked out of the property market.
Are you afraid of being locked out of the property market if you don't buy now?
This isn’t the case, you just might have to look at a different first property. It’s much more sensible than being locked into a home loan as interest rates rise, and finding that you’re under a lot of stress paying it back.
When considering whether you can afford mortgage repayments, you need to think about not just the next 12 months, but the next 5 years at the very least. After all, it’s going to be 30 years at least until you own the home outright!
A good rule of thumb is to allow for interest rates up to 10%. This way you’re leaving yourself a comfortable buffer every month. You might need this for repairs and maintenance, bills, and other unexpected expenses that come with the responsibility of owning property!
When is buying now with LMI worthwhile?
Just the fact of owning your own home and building equity as a form of forced saving could make the cost of LMI worthwhile as you establish your financial security for the future
The important thing is that you understand the costs that are involved, and that you have the right protections in place in the event that you can’t meet your monthly mortgage payments. This means seeking financial advice from a financial planner and talking over your plans with your accountant.
When you pay LMI, you're able to get the stability of owning your own home much sooner than if you tried to save the full 20% deposit.
How can I benefit from LMI?
If we return to our example above of purchasing a $330, 000 home, a 20% deposit would be $66, 000.
Purchasing with a 5% deposit and paying your LMI upfront will cost $31, 000. This is a much lower cost than the 20% deposit of $66, 000.
In this example, paying the LMI upfront rather than as part of the mortgage (so there's no interest paid on LMI), you're setting yourself up to get ahead financially.
If you do opt to purchase a property with LMI, you could plan to make extra mortgage repayments to increase the equity you hold in your home and to reduce the interest you’ll pay over the life of the loan.
This will help to claw back some of the cost of LMI, making it worthwhile in the long run as you build your net worth by increasing the equity in your property.
This way you're setting yourself up for home ownership sooner than if you'd tried to save but hadn't made it in your planned timeframe. It's a smart way to force yourself to save and get ahead.
Do I Have Any Other Options?
The final option is to use a guarantor. If you have a family member who can pledge equity in their own property to take the place of your deposit, you won’t need to pay LMI. You will need to have 5% of the purchase price, plus costs.
If you take either of these options to buy your home without a full 20% deposit, take advantage of the opportunity to lock in a low interest rate and build your equity by paying down your mortgage faster, or save and diversify your financial portfolio.
If you want to talk about your options with an expert, the Positive mortgage brokers will always offer candid advice and help you to plan a secure financial future.