Expert Advice with Ian Hosking Richards. 06/02/2012
I often speak with investors who do not appreciate the contribution that mortgage insurance can make to the creation of wealth. Mortgage Insurance is a one off charge that is paid by property purchasers who borrow more than 80% of the purchase price. It is charged on a sliding scale, so for example if your loan to value ratio (LVR) is 84% you will pay less mortgage insurance than if you are borrowing 95%. The amount charged can vary significantly from lender to lender, even given the same loan to value ratio, so it can pay to shop around. Premiums can vary from a few hundred to many thousands of dollars, depending on the amount borrowed and the LVR.
But what is mortgage insurance for, and who is the main beneficiary? Because higher loan to value ratios are deemed to be more risky to the lender, once the LVR goes above 80%, LMI (Lender’s Mortgage Insurance) is payable. It protects the lender from losses incurred if the borrower defaults and the proceeds of the subsequent sale of the property are insufficient to cover the total amount owed.
For example, let’s say a borrower buys a property for $400,000. They put down a 5% deposit and borrow $380,000. A few months later they lose their job. They do not have income protection insurance and are unable to make the monthly repayments. The lender repossesses the property and sells the property for $370,000. They have made a loss of $10,000 plus accrued fees, charges and interest. Once they have received the net proceeds of the sale they would approach the mortgage insurer to make up the difference between the money they have realized from the sale and the total amount owed. The mortgage insurer would pay out to the lender, and would then no doubt pursue the borrower for reimbursement.
Many borrowers aim to avoid paying mortgage insurance, which they view as an impertinent impost by the lender. They are forced to pay it even though the beneficiary in event of a future claim is the lender who made them pay it in the first place, yet they themselves receive no protection or benefit. Hardly seems fair really!
However I view mortgage insurance very differently. I see it as a valuable tool that gives me more leverage and enables me to grow my asset base much quicker. Say you have $100,000 in cash or equity as a deposit. This is sufficient to fund a $400,000 purchase at 80% LVR ($80,000 deposit + $20,000 to cover stamp duty, legals etc). However if we take the LVR up to 90% we could possibly purchase two properties at $300,000 each. This would use up $90,000 and still leave us with a $10,000 buffer. We will need to pay some mortgage insurance, but the benefit is that we have a larger asset base. Instead of increasing our asset base by $400,000 we have increased it by $600,000. If in the first year of ownership those properties go up by 10%, mortgage insurance has allowed you to invest in assets that have increased in value by an additional $20,000, more than enough to offset the cost of the initial premium.
Whilst mortgage insurance can at first glance appear to be a cheeky money grab by greedy lenders, the plain fact is that avoidance of LMI at all costs can often be a false economy, and severely curb the acquisition of further growth assets. For me it is just a cost of doing business. When lenders assess your capacity to borrow they look at your available funds to complete as well as your ability to make the repayments. If your aim is to grow your wealth by acquiring as many quality assets as possible, the only time that you should avoid paying mortgage insurance is when you will run out of serviceability before you run out of 20% deposits. Although mortgage insurance premiums can be quite steep, most investors would not have to pay the premium with cash – it can easily be ‘capitalized’ or added to the loan amount. For example, you may ask for an 85% LVR, but once the premium has been added in your end LVR could be 87%. So if you are one of those investors who have resented LMI in the past, take another look, it could prove to be a valuable tool that can help you achieve your goals much sooner than you thought.
Ian Hosking Richards is a successful property investor with a portfolio of over 30 properties. He is the CEO and founder of Rocket Property Group, a leading independent real estate agency that helps hundreds of people each year enter the property market or grow their existing portfolios.
For further information or assistance, please visit www.rocketpropertygroup.com.au or call 1300 850 038.
To read more articles by Ian Hosking Richards, click here
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.