If you’re considering refinancing your home, whether it’s to consolidate your debt, to access equity or to get a better deal, you need to properly assess the costs and benefits involved. Lenders mortgage insurance can, unfortunately, eat into any potential savings you get from switching.
Check your equity
One of the things you need to know early on in the process is your home equity – your home’s current market value minus any money you still owe on it. You may be able to get this estimated by a local real estate agent free of charge.
The reason it’s important to know your home equity when refinancing is because if you don’t have at least 20% equity, your new lender will require you to pay lenders mortgage insurance (LMI).
That means if your home is worth $500,000, you should be able to borrow up to $400,000 without needing LMI. Beyond this threshold, you’ll be subject to LMI premiums which can reach five figures, effectively wiping out any savings you’d make from refinancing.
What is Lenders Mortgage Insurance?
Lenders mortgage insurance (LMI) is designed to protect the lender when they enter the higher-risk scenario of lending over 80% of the home’s value. If you fail to keep up repayments and there’s a shortfall when it comes to selling the house on, they’ve covered their backs. Despite you having to foot the bill for LMI, it won’t do anything to help you if you fall into difficulties.
Your lender may well play down the cost of LMI by offering the option of capitalising your premiums. This means you add the cost of the insurance to your loan balance and pay it back along with your mortgage. Although this may seem more affordable, you’ll actually end up paying a lot more in the long run because the LMI cost will then be subject to interest.
If you paid LMI upon the initial purchase of your home, it may seem unfair that you’re being asked to pay it again. Unfortunately it can’t be transferred between lenders so there is no way around it if you’re borrowing 80% or more of the property’s value with a new lender.
This cost can be the biggest hurdle for many homeowners who are trying to switch to a more competitive mortgage deal.
How much is LMI?
To give an idea of the kind of money we’re talking about, the table below shows an estimate of the premiums you’d be hit with for a loan on a property worth $400,000, with varying levels of equity. If you only hold 5% equity ($20,000), the LMI premium could be over $12,000. You can see how it would be tough to recover this kind of money from just switching to a more competitive rate.
If you’d like to get an idea of what the LMI premium could be for your own situation, make sure you’re sitting down and then visit LMI insurer Genworth’s premium calculator at genworth.com.au.
Indicative LMI when refinancing a home worth $400000
|Property value||$400 000||$400 000||$400 000||$400 000|
|Required loan value||$380 000||$360 000||$320 000||$300 000|
|Home equity amount||$20 000||$40 000||$80 000||$100 000|
|Equity as percentage of home value||5%||10%||20%||25%|
|Potential LMI cost||$12 426||$6408||$1095||Nil|
- If you’re refinancing but have equity of less than 20%, you’ll have to pay lenders mortgage insurance (LMI)
- The cost of LMI can wipe out any potential savings from switching to a better deal, so calculate the benefits carefully
- Don’t be tempted to add LMI costs to your loan balance as the interest charges will make it even more expensive
- LMI can’t be transferred between lenders