Friday, 21 December 2012

Lenders Mortgage Insurance - The Ned Kelly of the Insurance Industry

Most of you would know that if you wish to take out a housing loan from a bank or lending institution, where you have less than 20% of the value of the property, you will be required to pay a premium for Lenders Mortgage Insurance (LMI), that is usually offered by a third party insurer, not the financial institution.

The amount of this premium will depend on how much less than 20% deposit you have.

LMI insurance protects the lender from any losses that they may incur as a result of you defaulting on the loan or ceasing to make payments etc.

Even though the lending institution has a first mortgage and is able to sell your property, the LMI protects them against any short fall in sale price against the outstanding loan balance.

You may, or may not know, that LMI only protects the lender and does not offer any protection to the borrower. The LMI provider may then also take legal action against the borrower to recoup their payment to the lender.

Now, here is the “Ned Kelly” bit. Your Lenders Mortgage Insurance is taken out for the term of the loan and in many instances this is 30 years. However, through a change in work location, or for other reasons, you may decide to sell the property and purchase a home in another town, or need to purchase a larger home for an increasing family.

In this situation, you payment of premium for LMI, ostensibly for 30 years cover, is simply forfeited and your new home proposal is regarded as a new proposal subject to a new premium altogether – is this double dipping or not?

The key word is of course that the term of the policy is equal to the term of the loan, so when you pay out your loan, the term of the agreement has effectively ended.

There is some relief possibly available, depending on the wording of the policy, and you may get a partial refund of premium if you sell you home within 12 to 24 months and repay the loan. However, if you have held the property for longer than this then the premium paid, ostensibly for 30 years, is simply forfeited to “Ned” (the insurer)

You may also be able to get a partial refund within the first couple of years of you get a new valuation (rising market) that effectively reduces your Loan Value Ratio (LVR)

If you wish to substitute the security offered (your home) there may be no refund but no additional premium payable but the valuation must support the same quality of property.

If on the other hand you substitute security and there is an increase in the LVR or insured amount, then this will be deemed to be a new risk and a new proposal and a new premium payable on the new risk. A refund on the cancelled policy may be payable, but unlikely after one to two years.

So it is therefore preferable to have an ongoing loan of the same value with substituted security rather than just sell up and pay out the first loan and then identify and purchased another property with a new loan.

I doubt that many people actually get to keep their home for the full loan term of 30 years covered by Lenders Mortgage insurance and so these insurers, even though they have assessed the risk over the full term of 30 years, in a lot of cases, simply get away with your money after just a few years – just like “Ned Kelly”!


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