Housing affordability, pt.1: The rising need for LMI

For many Australians who took out a mortgage in the 1990s, the nightmarish double-digit interest rates are something they will never forget. The official cash rate peaked at a withering 17.5 per cent in January 1990.

While it is unfathomable for the current generation of home buyers to imagine contending with such high rates, saving for a deposit and purchasing a home have never been more difficult despite the cash rate sitting at a record low 0.10 per cent.

In this climate of housing affordability constraints and subdued wages growth, brokers could find that more of their clients (particularly first home buyers [FHB]) opt to pay lenders’ mortgage insurance (LMI). For many, LMI is becoming increasingly attractive as it enables them to get their foot in the booming housing market without having to save for years to have enough for a 20 per cent deposit (the proportion required to avoid paying LMI).

As such, this presents brokers the opportunity to capitalise on this increased demand by educating their clients around the mechanics of LMI and its true cost, cementing themselves as the trusted adviser making the Australian dream of home ownership come true.

Buyers paying LMI to fast-track home buying

Indeed, more home buyers have been using LMI as a tool to overcome housing affordability constraints. LMI provider Genworth underwrote over 76,500 LMI policies in 2020, up from almost 66,9000 in 2019 and almost 60,000 in 2018, according to data provided to The Adviser.

The higher LMI demand was reflected in Genworth’s results for the first half of 2021, which showed that new insurance written increased by 14.7 per cent year-on-year to $15.5 billion.

This was attributed to a combination of low interest rates, rising house prices, and residents spending more time at home amid lockdowns (which in turn intensified demand for property and increased prices).

It is therefore incumbent upon brokers to have conversations with their clients about the viability of paying LMI to access the property market immediately, ahead of further increases in prices and a rise in the official cash rate (some lenders have already raised longer-term fixed rates in anticipation).

Some mortgage brokers like Astute East Brisbane finance manager Tony Duncan have already been seeing an increase in the volume of borrowers choosing to pay LMI.

“I think the simple fact that we are seeing a lot more FHBs in the market does automatically skew the numbers a little bit more towards LMI,” he told The Adviser. “If we look at FHBs, pretty much the majority of those require LMI. They’re probably having to push to the top end of their budget to try and secure a property.”

While brokers could propose other options to fast-track FHBs’ property purchase, such as the First Home Loan Deposit Scheme (FHLDS), stamp duty concessions, they might not be viable due to the property price caps or because of limited availability.

Mr Duncan said that while he and his clients raise these options, he’s finding that “far fewer clients are actually opting to go down those lines or trying to find a price point within th[e schemes]”.

Furthermore, while some lenders are offering to waive LMI for borrowers with a deposit of less than 20 per cent, this is usually only limited to professionals with higher income, such as accountants, doctors, and lawyers.

Deposit hurdle pricing out FHBs

The increased FHB demand for LMI comes amid growing housing affordability constraints, especially since the onset of the coronavirus pandemic. A range of factors has combined to make home ownership a distant dream for many in the last 18 months, including steep property prices rises, propelled by high buyer demand (which itself was spurred further by government stimulus measures such as the HomeBuilder scheme), low interest rates, and low housing supply.

According to CoreLogic, the upper end of the property market has risen by 25.4 per cent in value over the last year, compared to 18.4 per cent across the middle of the market, and 16.7 per cent across the lower end. While the rate of growth is declining, it has already priced many home buyers out of the market.

Australian Bureau of Statistics’ (ABS) data showed that the average owner-occupier home loan increased from $445,343 in September 2020 to $530,821 in September 2021, while FHB owner-occupier loans rose from $404,386 to $467,159. NSW FHB owner-occupier loans saw an even sharper rise, from $481,609 to $563,548.

It is therefore unsurprising that saving for a deposit has become the principal hurdle for FHBs, particularly if they wish to buy in their desired locations.

Genworth’s First Home Buyer Report underscored this, revealing that the greatest barriers to owning a property among prospective and recent FHBs are housing affordability, saving for a deposit (with three in four prospective FHBs saying this has become increasingly difficult), and finding a suitable property within budget.

On average, it now takes around 18 years to save for a 20 per cent deposit for a median-valued house in Sydney, and 12 years for a unit. In Melbourne, it takes on average around 14 years and nine years to save for a house and unit respectively. Regulators have also acknowledged that this is a hurdle, with Australian Prudential Regulation Authority (APRA) executive director, policy and advice, Renee Roberts telling the House of Representatives standing committee on tax and revenue during its inquiry into housing affordability that “what we see in the market for first home buyers in particular is that the deposit is the constraint for them”.

“Serviceability is not the constraint… we do see first home buyers borrowing at higher LVRs but the serviceability is generally not the issue,” she added.

Reserve Bank of Australia (RBA) assistant governor (economic) Luci Ellis echoed this sentiment, stating that while borrowers have been able to service larger mortgages with the same repayment amounts due to lower interest rates, this inflated house prices.

“Some of this extra buying capacity financed an increase in the quality of the housing stock, but because most of the housing stock was already in place, the main effect was to bid up housing prices,” she said.

“This was captured in land prices. There were some distributional consequences to this. The price increases were greatest in the most desirable regions and neighbourhoods. So, first home buyers now have to save a bigger deposit relative to their incomes.”

As such, more FHBs are willing to pay LMI to overcome the deposit hurdle and break into the property market. The Genworth study found that two-thirds of FHBs with a deposit of less than 20 per cent paid LMI to buy their first property in 2021, up from 55.7 per cent in 2020, while four in five (82.7 per cent) prospective FHBs who are proposing a deposit of less than 20 per cent are likely to use LMI. 

Demystifying LMI myths

Despite higher demand for LMI, misconceptions abound about its function, underscoring the pivotal role of the broker in educating clients. For example, most borrowers believe the LMI protects them in case they default on their loan (mortgage protection insurance fulfils this role but this is a different product), while others believe LMI is paid to the lender (rather than from the lender to the insurer).

Only a small proportion of FHBs knows that LMI is an insurance policy that lenders take out to protect themselves against the risk of a borrower defaulting on their home loan repayments and the lender being unable to recover the full outstanding loan amount.

There are also negative perceptions about LMI among those who would prefer not to pay it, with data showing that 73.1 per cent of prospective FHBs have pledged to avoid paying LMI, while more than half believe that it would make them feel like they have failed in saving for a deposit.

Mr Duncan said he carves out time with his clients to clear these misconceptions, while framing LMI as an opportunity cost that could allow clients to bridge the deposit gap and enter the property market sooner.

He said: “If paying some mortgage insurance means that you can get into the market today, and it saves you paying rent or creates the opportunity for you to get a value increase on that property in six to 12 months’ time, that property would be worth far more than the LMI costs.

“It does make sense to simply move now, pay the LMI and do the transactions today.”

Managing cost expectations

A larger role of the broker is outlining all the costs of purchasing property because clients often do not realise it until they seek pre-approval and begin the home-buying process.

For example, if a borrower wishes to purchase a $500,000 property in Queensland, they would not only be required to save a 5 per cent deposit ($25,000), they would also have to cover LMI and stamp duty costs, and legal and bank fees, which could add up to over $40,000.

Mr Duncan said he discusses all of these costs with his clients from the outset, while allowing for unexpected costs.

“We spend the most amount of time just helping clients with getting their heads around all of the costs,” he said. “I think there’s a knowledge gap where clients tell us they did not realise how things worked, probably because no one’s explained it to them before. But once they understand how the numbers work, we find that they’re more amenable to moving forward.”

For clients who wish to refinance, brokers would need to flag that the LMI is not transferable to the new lender. According to Genworth chief executive Pauline Blight-Johnson, a lender will still look at the LVR to assess whether LMI is required.

She explained: “If borrowing more than 80 per cent of the value of the property, LMI is payable again, and may be capitalised into the loan balance (if borrowers elect to pay LMI upfront), so that additional interest is payable on the amount over the life of the loan.

“If the equity in the home has significantly increased, there may not be a need to borrow more than 80 per cent with the new lender and therefore no LMI is required. The equity can increase if the market value of the property has risen considerably or if a reasonable amount on the principal of the loan has been repaid.”

But LMI proposals submitted to providers by lenders are usually completed within one business day after submission, so it shouldn’t delay the mortgage process. Moreover, Genworth has delegated underwriting authority to many lenders, meaning they complete LMI reviews in-house as part of the loan assessment.

Education is key

As housing affordability constraints intensify, mortgage broker education has become crucial to remaining abreast of LMI developments.

Brokers could use resources available on websites such as LMI videos and calculators to not only educate their clients but confidently guide them on making appropriate decisions for their individual circumstances.

However, before discussing the nitty-gritty of LMI, brokers must gauge whether saving for a deposit is the key hurdle for clients, and then work backwards to identify their maximum purchase price if they paid LMI.

As Mr Duncan posited: “I see LMI as a facilitator for purchasing property at a potentially higher price, and securing greater value without undermining the lending market.

“I think the fact that we have recourse lending and LMI in Australia which effectively supports the banking network to prevent substantial losses is a good thing.”

Partner Message

Prospective first home buyers are more eager and ready than ever to get their foot on the property ladder in an increasingly heated property market. These conditions have further intensified the “fear of missing out” and a sense of urgency before prices rise further out of reach.

“First home buyers are adopting several strategies to fast-track their homeownership goals from targeting more affordable properties, both by type [and] location to adjusting their living expenses. More than 80 per cent of first home buyers concede that their first home will not be their ideal or dream home,” says Pauline Blight-Johnson.

As more home buyers look set to fall short of the typically required 20 per cent deposit, awareness of Lenders Mortgage Insurance (LMI) has increased and is regarded as a strategy to bridge the deposit gap to enter the market. Mortgage brokers have an opportunity to provide guidance and information on options available. They support first home buyers by taking away the complexity on the home buying journey.

TOP tip for advising on LMI

Discuss options for paying LMI with your client, such as capitalising into their home loan and paying off with their interest, or paying upfront.

EASY LMI
Genworth recently began offering home buyers the option of paying LMI via monthly instalments, which does not impact the LVR. Once the LVR drops below 80 per cent, the monthly fee payment will stop. Gateway Bank also launched monthly LMI in conjunction with Genworth to enable borrowers with limited savings (but strong cash flows) to purchase property.

Pauline Blight-Johnson

CEO and managing director
Genworth