The changing face of LMI

One sector of the home loan process that has undergone constant change is the lender’s mortgage insurance (LMI) market. From being scrutinised in the 2018 Productivity Commission inquiry report into competition in the Australian financial system (2018 PC report) to lenders and the government announcing an array of policy shifts around LMI in the last year, it is not an area that has stood still.

It is estimated that around one-quarter of borrowing households take out a mortgage with LMI, with this number increasing in recent years.

But what exactly does this product do, and is it still relevant?

LMI under the microscope

A common misconception among borrowers is that lender’s mortgage insurance is a policy that covers the borrower in case something goes wrong on their loan.

In fact, the opposite is true. According to one of the largest LMI providers, Genworth Australia, LMI is insurance that protects the lender in the event that the borrower defaults on their home or investment loan. If the security property is required to be sold as a result of the default, the net proceeds of the sale may not always cover the full balance outstanding on the loan. Should this be the case, the lender is entitled to make an insurance claim to Genworth for the reimbursement of any shortfall. Where a claim for loss is paid to a lender, the insurance provider may seek recovery from the borrower, or any guarantor, for any shortfall amount.

As the lender’s risk has been reduced, it is able to lend the funds for a property to a borrower with a smaller deposit – sometimes as low as 5 per cent of the value of the property.

Therefore, in essence, the product enables borrowers to enter the property market sooner than otherwise by reducing the size of the deposit they need to save (as little as 5 per cent instead of the usual 20 per cent that lenders require).

“Because the lender takes out an insurance policy on that loan, it transfers the risk of the home buyer not being able to meet the repayments onto Genworth,” Pauline Blight-Johnston, Genworth Australia’s CEO and managing director, tells The Adviser.

Genworth works with a broker network that discusses LMI with all types of clients, including FHBs, investors and home owners wanting to refinance.

Originally, the product was touted as being particularly useful for lower-income earners, who are not traditionally a strong cohort of home buyers. But given the cost of housing in Australia, LMI has actually become particularly useful for middle-income earners in recent years, according to the 2018 Productivity Commission report into competition in the Australian financial system.

After considering the history of LMI and its role in improving housing affordability for borrowers (as well as commission arrangements between banks and LMI providers that may have created an incentive for lenders to use particular LMI providers), the report found that middle- and high-income earners are the most likely beneficiaries of LMI.

Further, while it was seen as a leg-up for FHBs, the 2018 report pointed to data which showed that it was more widely used by higher-income home buyers.

“Data from 2016 show that the income distribution of families taking out a mortgage with LMI was very similar to all families who took out a mortgage, and that very few low-income families took out mortgages, even with LMI,” the PC report stated.

“LMI is thus more accurately described as a tool that assists borrowers at all income levels to purchase more expensive housing than they might otherwise be able to afford rather than a way in which low-income earners are assisted to enter the housing market.”

Moreover, the report said, the extensive use of LMI would increase the availability of credit and therefore contribute to an increase in property prices, thus putting the goal of home ownership further out of reach for 
low-income borrowers.

“LMI therefore has limited usefulness in addressing housing affordability and should not be relied on to do so,” the report stated.

Instead, its strength comes in enabling borrowers to enter the property market sooner than they would otherwise by reducing the amount of deposit they need to save 
to secure a mortgage.

Ban on bank commissions

Like most products in the financial space, LMI has also been through a review process in recent years. An independent review of the Code of Banking Practice by Phil Khoury (the Khoury review) reported that fairness issues had been raised in relation to the costs of LMI passed on by banks to their customers.

Following the Khoury review, the Australian Banking Association agreed to implement 96 of the 99 recommendations in its updated code of conduct (the banking industry’s customer charter on best banking practice standards).

One of its recommendations was to impose a disclosure regime whereby signatory banks would disclose to their customers any discount commission or rebate received by the bank when the policy was drawn up or cancelled.

The first stages of the new code came into effect in July 2019, which included the following charter: “We will not charge you more for lender’s mortgage insurance than the actual cost we incur for that policy. We will not receive a commission on your lender’s mortgage insurance policy.”

The ban on banks being able to charge commissions on LMI reduces the perceived incentive for banks to encourage borrowers to take out a home loan with LMI. But demand for the product is still there.

Genworth’s half-yearly results for 2020 revealed that there was still strong demand for LMI in the first half of this year.

Genworth, which holds 50 per cent market share by gross written premium and around 1.2 million insured loans in-force, delivered higher volumes in its core LMI business, with new insurance written (NIW) up 8.1 per cent from $12.5 billion in the first half of 2019 to $13.5 billion in the first half of 2020.

According to the insurer, the gains reflected housing market growth in major capital cities pre-COVID-19
and the benefits of a low-interest
environment.

“Volumes continued to grow over the second quarter, with strong lender customer performance accompanied by improving customer confidence as COVID-19 restrictions began to ease,” the insurer said in its earnings update to the ASX.

Moreover, Genworth’s first quarter 2020 earnings report in May showed that the group had performed strongly over the first quarter (pre-COVID-19), with NIW up 18.5 per cent to $6.4 billion.

These results illustrate that demand for LMI in Australia was growing before the economic impacts of COVID-19 stymied this growth.

Genworth did not change its underwriting standards and guidelines in light of the COVID-19 crisis, but it is applying a higher level of scrutiny to applications.

The LMI market today

Since the beginning of this year, 
there has been a barrage of announcements, both from the federal government and lenders, for brokers to keep pace with the way they are treating LMI.

In January, the federal government’s First Home Loan Deposit Scheme (FHLDS) launched, enabling FHBs who earn $125,000 or less (or $200,000 or less for couples) to access a mortgage with a 5 per cent deposit without needing to pay LMI. Instead, the government guarantees the difference between the borrower’s 5 per cent deposit and the required 20 per cent deposit.

Prime Minister Scott Morrison said the measure, which is overseen by the National Housing Finance and Investment Corporation, would help FHBs save around $10,000 in LMI costs.

The scheme first launched in January 2020, with 10,000 places being made available in the first round between January to June 2020. A further 10,000 places have opened for the second round during 2020-21 financial year.

Lenders have also been busy offering deals on LMI – particularly waivers or reductions for high-net-worth individuals.

According to Ms Blight-Johnston, with the residential mortgage market being very competitive, lenders often develop special offers to attract new customers, including fee waivers, cashbacks and discounted interest rates.

“Sometimes they offer a reduced LMI premium rate or they absorb part or all of the LMI premium costs themselves,” she says.

For example, Westpac subsidiary St.George Bank targeted FHBs with a deal that reduced LMI costs to just $1 for FHBs with a 15 per cent deposit (restricted to loans of up to $850,000 for owner-occupier FHBs with principal and interest repayment terms).

ANZ is also offering to waive LMI for lawyers and accountants (in addition to medical professionals) who wish to access 95 per cent loan-to-value (LVR) mortgages, should they meet certain eligibility criteria.

In contrast, the Westpac Group also tightened its residential lending LMI policy in April 2020 to reflect changes in the economic outlook due to the COVID-19 crisis.

The major bank informed brokers that its LMI waiver offering, previously available for loans with an LVR of up to 90 per cent, had been withdrawn for the industry specialisation sector (accountants, lawyers, engineers) and the sports and entertainment sector.

In addition, the threshold for LMI fee waivers for qualifying medical professionals was reduced from a maximum LVR of 90 per cent to 85 per cent.

The future of LMI

While lenders announcing LMI waivers for borrowers who fulfill certain conditions might raise questions about the future viability 
of LMI, economists have pointed to the dangers of these waivers.

Commenting on these LMI waivers, economists warned that they could encourage riskier borrowing patterns in a period of uncertainty in the property market.

Saul Eslake, economist at Corinna Economic Advisory, said: “Reducing LMI leaves borrowers, and potentially lenders themselves, more exposed in the event that property prices fall, which is quite plausible, and may encourage people to take on more debt than they can sustainably service.”

This is an indication that the role of LMI is to prevent borrowers from taking on more debt than they can service, especially during times of economic upheaval. This is reflected in Westpac’s move to tighten its LMI criteria amid the COVID-19 crisis.

Ms Blight-Johnston says Genworth has also had to adapt its offerings to keep pace with changing lender and borrower needs.

For example, it has developed a monthly premium LMI product to give borrowers the choice of paying their premium monthly or as a one-off fee added to their mortgage.

“Recent home buyer research found that 56.2 per cent of respondents would prefer to pay monthly,” she says.

“We are talking to lenders about this product now and have had a lot of interest, as it’s great to provide borrowers with options.”

Ms Blight-Johnston also believes brokers play a vital role in guiding borrowers who do not have the 20 per cent deposit.

“We work closely with our broker network so they can advise their clients when LMI may be appropriate for them,” she says.

Window of opportunities for brokers

All of these changes are opportunities for brokers to educate and guide 
their clients through the myriad changes, cementing themselves as a borrower’s trusted mortgage adviser.

Aussie Home Loans recently revealed that home loan enquiries from FHBs in June soared by 219 per cent from the previous corresponding period, and this segment of the market is the one most in need of a broker’s guidance in the buying process.

Whether it is helping FHBs navigate the ins and outs of saving for their deposit and how LMI can help, or trying to help them secure a mortgage with smaller deposit through the FHLDS, knowing the ins and outs of what is happening in the LMI space and how this can benefit the borrower is paramount.

But the opportunities are not limited to the FHB space. As Ms Blight-Johnston says, LMI might still be a useful tool for some borrowers who have not yet saved the 20 per cent deposit.

It is therefore key for brokers to keep track of LMI updates to ensure that they can guide their clients through the various LMI policy changes and determine whether a waiver would suit their personal circumstances, including their profession, income and ability to service debt.

Above all, brokers can educate clients that the purpose of LMI is a vehicle to protect lenders, and remove the misconception among the public that it is an insurance to protect borrowers.