Mortgage Insurance

In Australia, the term “mortgage insurance” usually refers to two distinct types of insurance, and it’s crucial to understand the difference as they serve entirely different purposes and benefit different parties:

1. Lenders Mortgage Insurance (LMI): This is the more common and often mandatory form of “mortgage insurance.”
2. Mortgage Protection Insurance (MPI): This is an optional form of insurance that protects the borrower.

Let’s break down each one:

1. Lenders Mortgage Insurance (LMI)

What it is: LMI is an insurance policy that protects the lender (the bank or financial institution), not the borrower, in case the borrower defaults on their home loan repayments and the sale of the property doesn’t cover the outstanding loan amount. Essentially, it covers the lender’s potential financial shortfall.

Coverage:

• LMI covers the lender’s loss if you default on your home loan and the property is sold for less than the outstanding loan balance.
• Crucially, it does NOT protect you, the borrower, from financial hardship or from having to repay the debt. If the LMI insurer pays the lender for a shortfall, the insurer then has the right to pursue you (the borrower) to recover that amount.

When it’s required:

• LMI is typically required if your deposit is less than 20% of the property’s purchase price. This means your Loan-to-Value Ratio (LVR) is generally above 80% (e.g., 85%, 90%, 95%).
• Lenders consider loans with an LVR above 80% to be higher risk, and LMI mitigates this risk for them, allowing them to lend to borrowers with smaller deposits.
• It’s a one-off, upfront premium paid by the lender to the LMI insurer, but the cost is almost always passed on to the borrower.

How it’s paid:

• You can usually pay the LMI premium as a one-off lump sum at settlement.
• Alternatively, most lenders allow you to “capitalise” the LMI premium, meaning it’s added to your total loan amount. While this avoids an upfront cost, you will then pay interest on the LMI amount over the life of your loan, increasing the overall cost.

Average Premium (for LMI): The cost of LMI is highly variable and depends on several factors:

• Loan-to-Value Ratio (LVR): The smaller your deposit (higher LVR), the higher the LMI premium.
• Loan Amount and Property Value: Larger loans and more expensive properties generally incur higher LMI.
• Lender and LMI Provider: Different lenders use different LMI providers (the main ones in Australia are Helia and QBE LMI), and their rates can vary. Some lenders self-insure or have specific waivers.
• Loan Purpose: Owner-occupied vs. investment property.
• First Home Buyer Status: Some government schemes can reduce or waive LMI for first home buyers.
• State/Territory: Stamp duty may apply to the LMI premium, which varies by state (e.g., NSW and QLD 9%, VIC and WA 10%, SA 11%, ACT previously had it but now abolished).

General Cost Estimates for LMI:

• LMI can cost anywhere from a few thousand dollars to over $40,000.
• As a general rule, LMI can be around 1% to 5% of your home loan amount, depending on your LVR.
• Example from Money.com.au (approximate, for a $600,000 property): 
  • 20% deposit (80% LVR): $0 LMI
  • 15% deposit (85% LVR): ~$12,850
  • 10% deposit (90% LVR): ~$22,835
  • 5% deposit (95% LVR): ~$26,305

LMI Waivers:

• Some lenders offer LMI waivers for certain high-income professionals (e.g., doctors, dentists, lawyers, accountants) even with smaller deposits (e.g., 10% or sometimes even less). This is because these professions are deemed lower risk by lenders.
• Government Schemes: The First Home Guarantee (FHBG), Regional First Home Buyer Guarantee (RFHBG), and Family Home Guarantee (FHG) schemes allow eligible buyers to purchase a home with a smaller deposit (e.g., 5% for FHBG) without paying LMI, as Housing Australia (a government body) guarantees the loan instead.

2. Mortgage Protection Insurance (MPI)

What it is: Mortgage Protection Insurance is an optional type of insurance that is a form of Consumer Credit Insurance (CCI). It’s designed to help the borrower meet their home loan repayments if they experience unforeseen circumstances.

Coverage: MPI typically covers events such as:

• Involuntary Unemployment: If you lose your job through redundancy.
• Temporary Disability/Illness: If you are unable to work due to sickness or injury for a period.
• Total and Permanent Disability (TPD): If you become permanently unable to work.
• Death: Pays out a lump sum to clear or reduce the outstanding mortgage.

How it’s paid:

• MPI is usually paid via monthly premiums that are added to your loan repayments.

Average Premium (for MPI):

• Like other CCI products, it’s hard to give an exact average. Some sources suggest it can be around 0.5% to 1% of the loan amount on an annual basis.
• However, as discussed in the “Consumer Credit Insurance” article, ASIC has found that CCI products, including mortgage protection insurance, often offer very poor value for money, with low claims payout ratios compared to premiums paid.

Trends in Mortgage Insurance in Australia

1. Continued Relevance of LMI: LMI remains a fundamental part of the Australian mortgage market, enabling borrowers with smaller deposits to enter the property market sooner. Given high property prices, many Australians continue to rely on LMI.
2. Increased Scrutiny on MPI/CCI: As mentioned, Mortgage Protection Insurance (as a form of CCI) has been heavily criticised by ASIC for poor value and mis-selling. Many major banks and lenders have ceased offering it directly to new customers.
3. Rise of Government Guarantee Schemes: Programs like the First Home Guarantee are gaining traction as a way for eligible buyers to avoid LMI. This offers a direct alternative to paying the LMI premium.
4. Professional LMI Waivers: Lenders are increasingly offering LMI waivers to specific high-earning professionals, recognising their lower default risk. This is a targeted way to attract desirable borrowers without requiring a 20% deposit.
5. Focus on Borrower Financial Resilience: Instead of relying on add-on products like MPI, the focus is shifting towards borrowers having comprehensive standalone personal insurance (income protection, life, TPD) to protect their overall financial situation, not just their mortgage. Financial advisors typically recommend these broader policies over specific mortgage protection insurance.

When considering mortgage insurance in Australia, it’s crucial to understand the distinction between LMI (for the lender) and MPI (for the borrower) and to always seek independent financial advice.