“If buying a second property means having to pay LMI on both loans, is it still a wise decision or should you wait in today’s current property market?”
To answer this question, it is critical to understand: what is LMI?
LMI, or Lender’s Mortgage Insurance, is an insurance policy which you’re required to take out if the amount of money you borrow exceeds that lender’s comfortable loan-to-valuation ratio. For most lenders, this level is 80%, although some lenders will cover the premium up to 85%. While the borrower has the obligation to pay the premium on such a policy, LMI is a policy that protects the bank, not the borrower.
Taking this one step further, a loan-to-valuation ratio refers to the relationship between the loan and the value of a property. For example, if you are buying a property valued at, say, $500,000, then the maximum comfortable level of borrowing for a lender would be $400,000, or 80% of the value. At this level, should the borrower experience some degree of financial distress and be unable to pay the loan, the property is likely to be able to be sold, and enough funds recovered to at least cover the remaining loan balance, even if the market is soft or the property was purchased at over market value.
Once a borrower begins to request more than 80% of the value of the property, the risk to the bank becomes greater. At 95% for example (the highest that a lender will allow), the risk that a forced sale will not recoup enough to pay the balance of the loan (especially when selling costs are taken into account) is at its greatest.
It is for this reason that the higher the loan-to-valuation ratio, the greater the premium. In addition to the fact that the more you borrow, the higher the premium will be (as it is a percentage of the total borrowing), the closer you get to 95%, the greater that percentage becomes. So, for example, at 83% borrowing, the percentage you would pay would be around 0.6% (or $600 for every $100,000 borrowed), and at 95%, the figure would be 2.6%, or $2,600 for every $100,000. Further, as the loan amounts grow higher, these percentages shift higher too – a $750,000 loan at 83% would have premiums of $1,100 for every $100,000 while at 95% that same loan would have premiums of $4,600 for every $100,000!
I am sure you can see where this is going. If you were to borrow $750,000 with a total loan to valuation ratio of 95% because you really wanted to get into that second property, you would be required to pay LMI of $34,500. This is a huge impost, and the property you bought would need to have significant growth, and quickly, to make this added cost worthwhile.
My position on LMI is clear – unless you absolutely believe that what you are buying will grow exceptionally well (it needs to grow twice as fast as a property which doesn’t need LMI to buy it), or it is an absolute must that you buy that second property, and you can hold it for the many years needed to make this gamble pay off, you are better waiting until you have either more deposit, or more equity in property, to bring your loan-to-valuation ratio to, at the most, 85%.
