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How important is mortgage insurance?

By Rikki Cook

Does your mortgage include mortgage insurance? You could lower the size of your deposit or remove the need for additional guarantees by purchasing this type of insurance policy to increase your lender’s ability to secure their risk. Doing so can be an important bargaining chip if you are applying for a mortgage but fall a little shy of the deposit initially asked for.

What is mortgage insurance?

Mortgage insurance indemnifies the lender against the possibility of not being able to recover a full loan balance. Your bank can purchase this coverage as “Lenders Mortgage Insurance (LMI)”, in which case they will typically pass on the cost to you as a surcharge on your monthly payments, or you can buy mortgage insurance independently.

Benefits of mortgage insurance

Private mortgage insurance or an LMI policy can help convince a lender to provide a home loan to you if you meet all of their lending requirements but do not have a significant deposit. It may also help if you are low-income, low-equity, a first-time home buyer or have any other characteristics that place you in a high-risk category from the lender’s point of view. If your lender is asking for a deposit in excess of 20% (the normal ceiling for a home loan) or is assigning a high interest rate based on risk, you may be able to arrange mortgage insurance instead.

How mortgage insurance or LMI works

The mortgage insurance protects your lender against financial loss if you default on your home loan. It’s assumed that the property would be repossessed and sold. However, if the property doesn’t sell for an amount equal to or in excess of what is owed on the loan, the mortgage insurance will pay off the balance.

How are premiums arranged?

Your premium may be spread out among your loan payments, or payable up front in a lump sum on settlement. If you refinance, you may have to buy a new policy, especially if your equity in the property is still low (typically less than 20%).

In case of default

Be aware that even if you default and the property is sold, if the insurer has to pay off a balance, they may pursue you to recoup their losses. Always talk to your lender as soon as possible to try and arrange a new payment plan if you think you are going to fall behind.

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