Mortgage Insurance – Sex, Lies and Deception (But without the Sex) part one

When I first began to look into mortgage insurance, I thought that I would be able to cover all the info I found in one post. It’s turned out that if I do that you’d be reading something equivalent to War and Peace.

As a result, I’ve broken this article down into a number of installments. Today’s installment will cover the following:

• Mortgage Insurance may not mean what you think it means.
• It’s ok, ANZ assures us that there are benefits, not just for the bank, but for you too.
• How LMI Works
  • It’s only worth the shortfall
  • And then, you owe the LMI insurer the shortfall.

Mortgage Insurance may not mean what you think it means

My question for today is, “What did you think you were getting when you were told that you needed to get mortgage insurance on your home loan?”

I thought I was getting insurance for myself if something went awry. I was the one paying $10,070, so I figured I was the one getting the insurance – Silly me for not taking the time to read the fine print and also to discover the real name for mortgage insurance (my semi-legitimate excuse – I signed my loan contract with my two year old in tow, which, as I’m sure you can imagine, is highly conducive to being able to give something your undivided attention).

Mortgage insurance also goes by the name LMI which stands for “Lender’s Mortgage Insurance”. And if the name doesn’t give it away, then I’ll get NAB’s FAQ about LMI to answer what and who LMI is for,

Lenders Mortgage Insurance (LMI)

Insurance taken out by the lender (e.g. NAB) to protect itself from default by the borrower. Generally required for home loans with a Loan to Value Ratio (LVR) above 80%.

Link to NAB pdf that says this (glossary, pg 9) – accessed 13 Jan 2011

I chose NAB’s definition because it had my most favourite wording of all, “Insurance taken out by the lender to protect itself…” Where is the part where it says Insurance paid by the borrower???????????

You know what, I don’t feel like paying for my car insurance any more. I think I might ring up my local petrol station and ask them to pay it for me. They won’t mind because I’ll tell them that they won’t have to pay the amount up front, they can just absorb the cost when I fill up with petrol and if they don’t agree to this, then I won’t fill up with petrol there any more. There will be benefits for them too. Because driving my car around will be risk free, I’ll drive it more, thus use more petrol. It’s a Win Win!

Can someone please explain to me how my above suggestion is any more ludicrous than an insurance policy that the banks ask us to pay for them?

Wouldn’t a better alternative be, don’t lend money to people who are likely to default, or, I don’t know, suggest that a customer takes out insurance for themselves that, in turn, covers the banks?

It’s ok. ANZ assures us that there are benefits not just for the bank, but for you too.

This is the part where I enjoyed what ANZ had to say about the “Benefits of LMI” for the people (that would be you and me) who pay for this insurance,

Benefits of LMI

While LMI is primarily about protecting the lender there are also benefits for the borrower.

·   It allows buyers to buy a home sooner with a smaller deposit.

·   When trading up, it can increase your choice of properties by allowing you access to a wider price range.

·   It allows borrowers to retain some of their capital for other purposes – buying a car or investing in shares.

link to ANZ page with this content –  accessed 13 Jan 2011

I think what ANZ really means is, it allows us to take a bigger risk (profit profit profit )and offer you something before you’re in a position to 100% be capable of affording it.

Banks imply that LMI is a favour that they are doing for us. And, yet, what are their benefits? Here’s my list of LMI benefits for the bank in addition to it “protecting” them,

• Banks get to charge you interest on your LMI too (more about this one later – it’s great!)

• Banks make even more money off you – Someone who borrows more than they can potentially handle pays SOOOOOOOOOOOOOOO much more interest.

• Some banks provide their own lender’s mortgage insurance (Westpac and ANZ). Does this mean they get us to pay them for insurance for themselves and when we can’t meet our repayments, they give themselves money and then come and chase after us to get back the money that they just gave to themselves? Hmmmmm….

And after all this, I really feel the need to ask, ‘What is to prevent our banks from paying for their own insurance?’ I’m sure they have every right to take out insurance, but that should be their responsibility to pay for it. I don’t ask them to pay for my insurance.

Now, I guess I really was juvenile when looking into this whole getting a home loan thing because I also didn’t realise the amount that LMI actually insured the banks for.

How LMI Works

This next bit is a little bit about how LMI works. To get us started, let’s have another look at ANZ (don’t worry, we’ll get to CBA and WBC) and their explanation,

How does it work?

LMI is a one-off fee paid by borrowers when they take out a home loan. Fees vary according to the amount borrowed and the size of your deposit.

In the event that the lender needs to sell their property and the proceeds do not fully repay the loan, the lender can make a claim for the difference from the insurer. In that case, the borrower is still legally liable to repay the insurer.

Link to ANZ’s “How Does LMI Work” page – accessed 13 Jan 2011

ANZ’s explanation tells you two things – Two very important things in fact:

1. It’s only worth the shortfall

2. You then owe the LMI insurer the shortfall

1. It’s only worth the shortfall

Lender’s Mortgage Insurance only covers your bank for the difference. The ‘difference’ is also known as ‘the shortfall’ and is the possible outstanding amount after the bank has sold your house. What I’m saying here is, LMI does not cover the cost of your entire property, just the remainder of the bank’s fire sale. Now, don’t fret. We’re going to do a little bit of maths to see exactly how much this ‘difference’ is likely to be.

In order to do this, let’s create a hypothetical Scenario (it’s a little convoluted, but I think it’s made that way so that we don’t look too closely at the numbers, so stick with me). This is also where I feel the need to add a disclaimer. I am not and likely never will be an expert on property or mathematical formulae. What I am is a housewife with two children and a large mortgage . So if you’re an expert and you come along and see that I’ve potentially failed in my equations, please let me know!

Jack and Jill buy their first home for $700,000 (the median house price in Sydney). Even though the house sells for a comfortable $700,000 (with competition and the like), the banks are being conservative and only value the property at 90% of the sale price which is $630,000 (I’m being generous here. Property advisors say that banks have been valuing 20-30% below the actual market value since the GFC).

Jack and Jill are actually in a pretty fortunate position because their parents have given them $70,000 towards their first home. The government is going to give them $7,000 and they’ve managed to save $35,000.

Because the banks don’t count the additional $70k above their valuation, Jack and Jill’s loan deposit is only $42k which is 6.6%. Therefore, Jack and Jill have to get LMI for their bank…

Home Loan Experts provide an LMI comparison table on their website. I used that to get an idea of what sort of mortgage insurance Jack and Jill would be up for. Below are the results that I got after entering in the above numbers.

Loan amount: 588,000.00
Property value: 630,000.00
LVR: 93.33%

Let’s assume that Jack and Jill’s LMI is the average of those prices listed above (it would be nice to go for the smallest, but let’s face it, most people don’t choose their mortgage based on LMI)

From what I understand of the LMI table above, the funds available is actually less than the amount required for the loan. But we’re going to pretend that the bank has loaned Jack and Jill the full amount at an interest rate of 6.57%

Two years down the track, Jack and Jill have got their mortgage down to $588,126.81 (in order to keep it a little simpler, we’re not factoring in extra repayments or interest rate rises).But then Jill falls pregnant and Jack loses his job. Things fall into a heap and 9 months later the bank has repossessed their first home.

At this stage the loan amount is back to approximately $598,744.08 (this number is hard to work out because you have to factor in individual bank’s late payment fees etc etc, so I’ve just taken the loan total back a year in time to where it was at the end of the first year).

The bank puts the property on the market.

Now… How much do you think it will sell for when it was purchased for $700,000 only two years before? Do you really think it will sell for less than $598,744.08? It would have to have been in a pretty bad area or a pretty major market crash would have to have followed for it to sell for less than that.If you’re wondering about the rumour that  mortgagee house sales sell for less, I spoke to a number of real estate agents who said they didn’t feel that this affected the sale. In addition to this, banks aren’t allowed to sell your house for a ridiculous amount. This means the likelihood of the house selling for market value is good.

So, what does this all mean? It means that, in Jack and Jill’s hypothetical, the ‘shortfall’ is essentially negligible. That being the case, what then is LMI for? If the banks are undervaluing houses, isn’t that enough of a coverage for possible shortfall? Do they really need to double it up by charging you for their insurance as well?

And on top of all that, most banks have a standard policy that for Low doc loans, which are considered a ‘risky’ loan (most likely to default), a maximum of 80% of the value of the property will be loaned. That means that they have a 20% buffer for the shortfall. And yet, on low doc loans LMI is required for a deposit less than 40%.

Now, I’m sure that there is occasionally a shortfall on mortgagee homes. There must be in order for banks to have invented such a wonderful insurance to cover for that possibility. And for that reason, I would be very interested to find out what the typical shortfall on a mortgagee home is. I tried to find out. Do you know? Is it actually a large amount? Or is it as negligible as my hypothetical situation makes it out to be? And is this some wonderful con conceived by the banks in order to make even more money?

2. You then owe the LMI insurer the shortfall

Did you worry that I’d forgotten to bring up the second important thing that ANZ told us about how LMI works? Of course not, I just took FOREVER to get there! No wonder I didn’t look into this stuff before I got my mortgage – I’ve only just begun with LMI and that’s only one facet of a home loan!

In case you’ve forgotten what ANZ said, here it is again,

the borrower is still legally liable to repay the insurer.

Go on. Do a double take. Does it mean what you really think it means? Of course it does! I had a chat with Westpac on the phone the other day and I asked them about this. The girl I was speaking to was extremely friendly when she told me that yes, the lender’s mortgage insurance insurer would pay the shortfall to the bank and then come and “politely” ask me to pay them back. She told me that Lender’s Mortgage Insurance doesn’t work like other insurances. Wow, aren’t you so glad you bought the bank their insurance!

The Westpac phone lady did tell me some good news though. If the shortfall is only a $1000 or so, they won’t bother you. They earn so much money that $1000 is really give or take. But if it’s closer to $10,000 you better cough up. Otherwise they are legally allowed to sue you and worse. The good news is that there is (at present) no interest on the shortfall. Although LMI insurers are legally allowed to charge interest, they figure they’ve gotten you so cornered that you just wouldn’t cope with the interest.

In case all of that was way too much of a mouthful for you, here’s a summary of today’s LMI installment in point form:

• Mortgage insurance is actually called Lender’s Mortgage Insurance (LMI) (why don’t the banks just call it Lender’s Mortgage Insurance when they talk about it with you when applying for your home loan?)
• Even though you pay for the LMI, it is insurance for the bank, not for you.
• LMI only covers the bank for the possible (from our conclusions, nearly non-existent) shortfall that occurs when the bank has sold your property and re-claimed their loan amount.
• If there is a shortfall of the loan amount from the sale amount, then the LMI insurer will find you, the borrower, legally liable to repay them. But Westpac said they wouldn’t bother if it was only a $1000 or so. How kind.

I don’t know about you, but that’s definitely more than enough to take in for one day. Now, don’t feel too down in the mouth. We’ve got more stuff to look at and quite a lot of it is positive. Here’s a quick preview of what’s to come,

• Comparing LMI to other insurances
• Other LMI crappies (well, this is kinda what ANZ calls a ‘benefit’)
• Some LMI Sneakies
  • When you re-finance, it’s likely you’ll have to pay your new lender mortgage insurance too – YAY! But what they avoid telling you is, that you might be eligible for a refund from your old lender’s LMI.
  • LMI insurer meanies (that’s the technical term) when applying for a variation have less clout than they make out
• The helpful Stuff
• Alternate Options to LMI
  • Guarantor
  • Spend Less (stay within your budget)
  • Invest first, buy later
  • Mortgage Insurance for you
• If you’re stuck with LMI
  • Complain! This really is the most bogus insurance on the planet. It’s ludicrously rude.
  • Compare rates and terms and conditions
• Some hard to find facts which you might be interested to know
  • Which LMI insurer the big four use
• Some Useful Links

To continue reading about LMI, please here for

Mortgage Insurance – Sex, Lies and Deception (with a tiny bit of ‘sexy’ this time) part two

P.S If this stuff bothers you as much as it does me, please go and Spank Your Bank about it!