Creeping rental prices and increased lifestyle costs are making saving for a deposit difficult for a large number of Australians. But there is a smart technique first time buyers are adopting to leapfrog years of deposit saving and turn their dreams of home ownership into a reality. That is capitalising the Lenders Mortgage Insurance (LMI) premium into your mortgage.
Quick step past the rental trapLending in Australia has changed. The emergence of a new breed of lender and a more flexible attitude by some of the banks has given greater options to borrowers, especially first time buyers.
One of the main areas where home buyers now benefit from greater flexibility is through the growing willingness of lenders to offer higher loan amounts in relation to the value of a property (loan to value ratio, or LVR).
Moreover, through allowing borrowers to capitalise the LMI on higher LVR mortgages – which entails adding the LMI premium to their mortgage and servicing it as part of their ongoing monthly loan repayments – more Australians are breaking free of the rental trap and achieving home ownership earlier.
Greater flexibilityBefore this evolution in lending, most borrowers could only expect to secure up to a maximum of 80 per cent of a property’s value, which meant the borrower had to front a 20 per cent deposit from their own pocket.
The good news is that most lenders will now offer 90 per cent LVR as standard, and some, 100 per cent or more. What this means for borrowers is that they are no longer forced to spend years in the rental market saving tens of thousands of dollars for a deposit. But this convenience does come with a cost.
Through taking a larger loan against a property’s value, the lender bears a greater risk should the borrower default on their mortgage. With housing prices fluctuating, this may mean the lender could end up out of pocket.
To mitigate this increased risk the lender will require the borrower to take out LMI – which allows them to pass on this risk to a mortgage insurer, like Genworth Financial.
While taking out LMI does add another cost to the overall purchase, it is likely to be considerably less than the outlay of a 20 per cent deposit. Moreover, when you consider the rate in which Australian property has historically climbed – as well as the increasing cost to rent property – it can be a small price to pay to achieve the dream of home ownership.
How can I pay the premium?While LMI does add to the initial upfront cost of a borrower’s loan, a growing number of lenders now allow borrowers to capitalise the cost of the LMI premium into the loan. This lets the borrower add the cost of the LMI premium to their loan amount, spreading the repayments.
Buying a home can be an expensive business, and the upfront costs – such as solicitors’ fees, stamp duty, and application fees – can soon mount. The flexibility offered through capitalising LMI can help ease the burden of these upfront expenses, freeing up cash to ensure a smoother transition to home ownership.
Although the monthly repayments are a fraction higher as a result of this technique, the benefit – both in terms of your lifestyle and acquiring an appreciating asset – can be a smart solution to escaping the rental trap.
Capitalising LMI – enabling faster home ownershipNewlyweds Tim and Erica are battling to save a deposit for their home. While living with Tim’s parents rent free is an option to help them save a deposit, they both enjoy the freedom of living independently– which means spending approximately 32% of their combined monthly salary on rent.
Paying rent is putting a real strain on their ability to save a deposit, as well as their marriage. Speaking with their mortgage broker, Tim and Erica are excited to learn that they can secure a mortgage for 95% of the value of the property they hope to buy if they take out lenders mortgage insurance (LMI).
Using the $10,000 they have saved to date for a deposit, as well as their $7,000 First Home Buyers Grant, Tim and Erica can comfortably meet the other commitments associated with their mortgage – such as solicitor and application fees.
These funds will not stretch far enough, however, to also cover the cost of the LMI premium. Keen not to miss out on the property they’ve decided to purchase, Tim and Erica’s broker advises that they can capitalise their LMI – which means adding the cost of the premium to their mortgage.
Purchasing their new home for $336,000, with a mortgage of $320,000 the monthly repayments on their 30-year mortgage (rate 7.5%) comes to approximately $2,238.
The LMI premium on their $320,000 mortgage comes to approximately $6,627. Should Tim and Erica capitalise their LMI it will increase their monthly mortgage repayments by $45, taking the total monthly mortgage repayment to $2,283.
Please note that pricing may vary between lenders. Please contact your lender for more information on product fees .
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