Mortgage insurance could earn you $240K

Spending tens of thousands of dollars in this way could be one of the best investments you could possibly make.

Spending tens of thousands of dollars on mortgage insurance probably doesn’t sound like the best thing to do, but in some cases it can be one of the best investments you could possibly make.

For the average property buyer in Australia, in some cases it will make you around $243k more than the cost you pay.

But there are a lot of myths around lenders’ mortgage insurance – some of them have merit and others just aren’t true. I wanted to bust some myths and help you understand what you really need to know to figure out if this is a smart path for you to consider.

What is lenders’ mortgage insurance?

Lenders’ mortgage insurance or ‘LMI’ is a cost charged by the banks to someone who purchases a property with a deposit that’s less than 20 per cent of the purchase price.

LMI exists to protect the banks from a borrower defaulting on their loan, but strangely (and a little annoyingly) while this insurance protects the banks and not the borrower themselves, the borrower is the one that needs to pay for the insurance.

LMI protects the banks and not the borrower, yet the borrower is the one that pays for the insurance. Picture: iStock

Who pays LMI?

Everyone who buys a property with a deposit less than 20 per cent needs to pay LMI, but there are a few exceptions. Certain banks offer lower thresholds for LMI to people that work in certain professions and industries that the bank considers lower risk.

For example, people working in the medical industry, as accountants or in finance, law, or essential workers can all access special rates for LMI. It’s worth chatting to a good mortgage broker who knows their stuff to check if you might qualify for an exception.

How much is LMI?

LMI is charged at a sliding scale based on the value of your property and the amount of your deposit. Consider this example.

In Australia, the average property price is $779,819, and if you were to buy a property of this value with a 20 per cent deposit you pay no LMI at all. If your deposit is less than 20 per cent, the LMI you’d pay is shown in the table below.

Deposit amount	19%	15%	10%	5%
LMI cost	$6,415	$9,635	$19,816	$35,827

As you can see from these figures, the smaller your deposit, the more you pay in LMI – and it can get quite expensive quite quickly.

Is LMI risky?

Once your LMI has been calculated and paid, your property purchase carries the same level of risk than any other property purchase.

It almost goes without saying, but it’s important to mention that the more you borrow, the higher your risk levels. This means that if you’re buying property, whether considering LMI or not, it’s important you crunch your numbers and have a good risk management strategy in place.

Is LMI worth it?

LMI can run well into the tens of thousands of dollars, and thinking about choosing to accept such a large cost when you’re already going to spend a heap of cash on a property is naturally off-putting.

You can completely avoid LMI by saving up more money, but with a rising property market, often delaying your property purchase can mean you need to spend more money to get the same property, and you end up further and further behind. Consider this example.

You want to buy a property at the Australian average property value of $779,819 using a five per cent deposit of $35,827. In this case, the cost of LMI would be around $35,827.

You can avoid LMI by saving more money, but delaying your property purchase can mean spending more on the same property. Picture: iStock

You could completely avoid LMI for this purchase by saving up an extra $116,973 to make up a 20 per cent deposit. For the sake of this example let’s assume you’re saving $2,000 monthly, meaning it would take you almost five years to do.

Over five years, the value of this property would increase roughly in line with the long term property market growth rate of 6.3 per cent, meaning your $779,819 property would now cost $1,058,425.

In this case you’ve avoided a cost of $35,827, but missed out on $278,606 in property growth, so you’re now $242,779 behind.

And worse, because the property value is now $1,058,425, the 20 per cent deposit needed to avoid LMI is now $211,685, not $155,964, meaning that you have even more money to save.

This saving will take even more time, and during this time it’s likely the value of your property will continue to increase further. This can become a vicious cycle that takes forever to get in front of.

The thought of spending tens of thousands isn’t a nice one, but in many cases the alternative is much more costly.

To say it another way, in this case paying $35,827 in LMI would make you $242,799. This is a good return on your money no matter which way you look at it.

$242,799 is a good return on your money no matter which way you look at it. Picture: iStock

Worth noting this is an example, and the exact figures and how it will impact you will depend on your numbers, so for anyone looking at this decision it’s important you run your numbers and get some good advice before making any big decisions. But you should be able to see from this that the conventional wisdom isn’t always as wise as you’d think.

The wrap

LMI is a chunky cost that most people would like to avoid, and the thinking here is completely logical – particularly for someone who’s about to spend big dollars buying a property.

That being said, you can see from the numbers that sometimes paying this cost can sometimes be the best move you could possibly make with your money. Take the time to understand your numbers and get this right – your future self will thank you for it.

Ben Nash is a personal finance and investing expert commentator, financial adviser and founder of Pivot Wealth. You can follow more of Ben’s free content on Instagram | Facebook | Podcast.

Ben is also the author of ‘Replace your salary by Investing’ and Get Unstuck, and runs regular free online money education events, you can check out all the details and book your place here.

Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstances before acting on it, and where appropriate, seek professional advice from a finance professional.