Questions frequently asked, are "Do I need Mortgage Insurance when Refinancing a Home?" and "What is Mortgage Insurance?"

In this article I will make clear Lenders Mortgage Insurance, when it is required and the benefits when Home Refinancing.

The function of Lenders Mortgage Insurance (LMI) is to protect the mortgage lender from incurring a loss of funds in the event of a borrower defaulting on their loan , ending in foreclosure and a ensuing mortgagee sale. If the proceeds from the mortgagee sale are not enough to pay back the mortgage in full, LMI will meet the loss for the home loan lender.

LMI shouldn't be confused with Mortgage Protection Insurance (MPI), which protects a borrower against their incapacity to repay their loan in the event of an unforeseen circumstance like unemployment, illness or death. MPI covers payment of your loan instalments and/or your loan balance. CPI insurance is not mandatory and is solely the decision of the borrower. The premium for CPI is paid annually and usually varies based on the size of the mortgage.

Why is Lenders Mortgage Insurance required?

Lenders including Banks, Building Societies, Credit Unions and non-bank lenders, either use money from deposits held in savings accounts and term deposits, or borrow cash to provide home loans to borrowers for home refinancing, purchasing, construction or equity purposes. By using other peoples' money to fund home loans, the lenders initiate an obligation to repay that cash to the suppliers of the money while at the same time taking on the risk that they may not get all or some of the funds back that they loan.

Even though they hold real estate property as security for the mortgage, the value of the property may decline due to market forces, contagion or damage to the improvements, concluding in the security not having adequate value to cover the amount of the home loan. To cover their obligations to the suppliers of the home loan funds, the lending institutions take out LMI to cover any possible shortfall.

Do I benefit from Lenders Mortgage Insurance?

Before LMI was available, lenders required borrowers to have a deposit of no less than 20% when buying a home or equity of 20% when refinancing a home to minimise the risk of lending and protect them against possible loss in the event of foreclosure. Nowadays with the ability to pass on the risk of loss to an insurance company through LMI, lending institutions are prepared to agree to a lower deposit for purchases and less equity for home refinancing.

Also, if lenders did not use LMI to relieve lending losses, then those losses would need to be recouped from the profits of other mortgages, in effect increasing home loan interest rates. To stay away from this, lenders opt to effect LMI and have the insurance company take on the risk and bear any loss.

By lending institutions using LMI, the advantage to borrowers is that they are able to buy a home using a lesser deposit or refinance a property with a reduced amount of equity and/or receive lower interest rates than they would otherwise be able to do with no LMI.

Please note, that even though LMI will give some worth to the borrower, it does not cover the mortgagor against loss resultant from foreclosure. LMI ONLY PROTECTS THE MORTGAGEE as in effect, they are the beneficiary of the insurance policy! In the event of a claim for loss, the mortgagee will receive the proceeds from the LMI claim, not the borrower. Any loss resultant from foreclosure, in spite of of LMI, is a loss incurred by the borrower and will remain as such. The only difference being is that the borrower's liability to the lender for the loss will transfer as a legal responsibility to the LMI provider for the loss in the event of an LMI claim by the lender.

Who pays the LMI Premium?

The LMI provider's contract of insurance is with the lending institution and the premium is payable by the lender though in certain instances the lending institution may pass on the cost of the insurance to the mortgagor as a cost of providing the home loan.

A home loan where a deposit or equity of less than 20% is permitted represents a higher risk to the lender, and in this occurrence the lending institution will normally pass the cost of LMI on to the mortgagor as a fee for them being able to obtain a loan that they would generally not have been able to acquire.

What is the cost of LMI and how is it paid?

The premium for LMI is a one off premium payable upfront on the day of settlement of the loan with payment of the premium being the responsibility of the lender. The lender will deduct the premium from the homeloan proceeds if and when the cost of LMI is to be met by the borrower.

The premium cost will vary based on the amount of the homeloan and the ratio of the loan size to the value of the security i.e. Loan to Value Ratio (LVR). The higher the LVR the more expensive the premium, also the bigger the homeloan amount the more expensive the premium.

Are the providers of Lenders Mortgage Insurance reputable?

LMI providers work under stringent government regulation to ensure they preserve sufficient liquidity to meet claims, as well as hold sufficient funds in reserve, in the event that a large number of claims are made in a short period of time or increase substantially.

How is Lender's Mortgage Insurance arranged?

The granting of LMI is not automatic and must be applied for by way of application to the LMI provider. Should your home refinancing need LMI, your Mortgage Broker, Planner or Mortgage Consultant in conjunction with the finance provider, will prepare all the essential documents and provide you with all the information about the application process.

Provided the mortgagor, loan structure, home refinancing objective and security property meet with the appropriate LMI provider underwriting guidelines an LMI Certificate of Cover will be issued to the lending institution.

As you can appreciate, Lenders Mortgage Insurance does give some benefit to the borrower in the form of lesser interest rates though it is chiefly utilised as a risk mitigation tool by the finance provider. When home refinancing the benefit of LMI is greatest when the security property equity is less than 20% as the borrower would normally not be able to attain such a loan. However that increased benefit comes at a price in the form of increased home refinancing costs.

So when refinancing a home it is vital to retain as much security property equity as possible, in effect reducing the cost and/or requirement for LMI and balance the worth being achieved from the home refinance with the cost of LMI.