LMI vs. Saving a Larger Deposit: Which Option is Best?
When it comes to buying a home in Australia, one of the most significant decisions first-time buyers face is whether to pay Lenders Mortgage Insurance (LMI) or wait and save a larger deposit. This choice can have substantial financial implications, both in the short and long term. Let’s explore the pros and cons of each option to help you make an informed decision.
Understanding Lenders Mortgage Insurance (LMI)
Lenders Mortgage Insurance is a one-off premium that protects the lender, not the borrower, if you default on your home loan. It’s typically required when you borrow more than 80% of the property’s value, meaning you have less than a 20% deposit.
Key Points about LMI:
- It’s usually a one-off payment made at the time of loan settlement
- The cost depends on your loan amount and the size of your deposit
- It can be capitalised into your loan, meaning you pay it off over time with interest
- LMI does not protect you as the borrower; it solely safeguards the lender’s interests
The Case for Paying LMI
1. Enter the Property Market Sooner
One of the primary advantages of paying LMI is that it allows you to enter the property market sooner with a smaller deposit. This can be particularly beneficial in a rising market where property prices are increasing faster than you can save.
2. Start Building Equity Earlier
By purchasing a property sooner, you can start building equity earlier. This equity could potentially be used for future investments or property upgrades.
3. Avoid Chasing a Moving Target
As property prices rise, the amount needed for a 20% deposit also increases. Paying LMI can help you avoid the situation where you’re constantly trying to save more as prices climb.
The Case for Saving a Larger Deposit
1. Lower Overall Costs
By saving a 20% deposit, you avoid paying LMI altogether, which can save you thousands of dollars. Additionally, a larger deposit means a smaller loan amount, resulting in lower interest payments over the life of the loan.
2. Potentially Better Interest Rates
Lenders often offer more competitive interest rates to borrowers with larger deposits, as they’re seen as lower-risk customers.
3. Increased Borrowing Power
A larger deposit can potentially increase your borrowing power, allowing you to purchase a more expensive property or have more financial flexibility.
Comparing the Costs
To illustrate the difference, let’s consider a $600,000 property:
| Deposit | Loan Amount | LMI Cost (Approx.) | Monthly Repayments (6% p.a., 30 years) |
|---|---|---|---|
| 5% ($30,000) | $570,000 | $26,305 | $3,417 |
| 20% ($120,000) | $480,000 | $0 | $2,878 |
In this example, opting for a 5% deposit and paying LMI would result in higher monthly repayments and an additional cost of $26,305 for LMI.
Factors to Consider
1. Property Market Conditions
In a rapidly rising market, the cost of LMI might be offset by capital gains if you enter the market sooner. However, in a stable or declining market, waiting to save a larger deposit could be more beneficial.
2. Your Savings Capacity
Consider how long it would take you to save the additional amount needed for a 20% deposit. If it would take several years, the opportunity cost of waiting might outweigh the cost of LMI.
3. Rental Costs
If you’re currently renting, compare the cost of rent over the time it would take to save a 20% deposit against the cost of LMI. In some cases, paying LMI and stopping rent payments sooner could be more economical.
4. First Home Buyer Schemes
Check if you’re eligible for government schemes like the First Home Guarantee, which allows eligible first home buyers to purchase a property with as little as a 5% deposit without paying LMI.
There’s no one-size-fits-all answer to whether paying LMI or saving a larger deposit is best. It depends on your individual circumstances, financial goals, and the property market conditions.
If you’re in a position to save a 20% deposit within a reasonable timeframe and the property market is stable, waiting could save you money in the long run. However, if saving a larger deposit would take several years and you’re concerned about being priced out of the market, paying LMI to enter the market sooner could be a smart move.
Remember, LMI is a significant cost, but it’s also a tool that can help you achieve homeownership sooner. Weigh the costs against the potential benefits of entering the property market earlier, and consider seeking advice from a financial professional to help you make the best decision for your situation.
Ultimately, the right choice will depend on your personal circumstances, financial goals, and risk tolerance. By carefully considering the pros and cons of each option, you can make an informed decision that aligns with your long-term financial objectives.