As a landlord, you’re always looking to grow your portfolio and increase your rental income. But saving up a deposit for each property can be a big ask, especially in Australia’s competitive real estate market. That’s where Lenders Mortgage Insurance (LMI) comes in.
This article will explain how LMI works, the benefits and risks for landlords, how it can help you achieve your property investment goals, and strategies to minimise costs. We’ll also look at examples of investors who have used LMI to build wealth through property.
What is Lenders Mortgage Insurance?
LMI is an insurance policy that safeguards the lender if a borrower fails to repay the loan or if the property is sold for less than the outstanding loan amount. By offering lenders extra protection, this insurance helps increase potential buyers’ accessibility to homeownership.
LMIs don’t offer any protection to the borrower and can lead to recovery efforts from the provider against the borrower if a shortfall occurs during the sale of the property. It may seem like an extra cost, but it can be a valuable tool for landlords looking to grow their portfolio faster.
How LMI Can Help Landlords Grow Their Portfolio
A Lenders Mortgage Insurance allows you to buy investment properties with a smaller deposit, typically less than 20% of the property value.
LMI impacts the loan approval process for home loans by mitigating lender risks, enabling you to get into the market sooner and buy more properties than you could if you had to save up a bigger deposit for each one. Here’s an example:
| Scenario | Without LMI | With LMI |
| Property value | $500,000 | $500,000 |
| Deposit required | $100,000 (20%) | $50,000 (10%) |
| Loan amount | $400,000 | $450,000 |
| LMI cost | $0 | $15,000 |
| Total upfront cost | $100,000 | $65,000 |
As you can see, using LMI allows you to buy the property with a smaller upfront cost and free up your capital for other investments or expenses. The loan amount also influences LMI costs and the overall affordability of the investment.
Tax Implications for Landlords Paying LMI
When it comes to tax, LMI can be a tax deduction for landlords. According to the Australian Taxation Office (ATO) you can claim a deduction for the cost of LMI over the lesser of the life of the loan or five years. So if you pay $15,000 for LMI on a 30-year loan, you can claim a deduction of $3,000 per year for five years.
Make sure you keep accurate records of your LMI payments and consult with a tax professional to ensure you’re claiming the correct deductions.
LMI and Rental Yields and Profitability
While Lenders Mortgage Insurance (LMI) can help you buy properties with a smaller deposit, it’s important to consider its impact on your rental yields and overall profitability. LMI is an extra cost that can eat into your returns, especially in the short term. Let’s look at an example:
Suppose you buy a $500,000 property with a 10% deposit and pay $15,000 in LMI. If the property generates a rental income of $500 per week, your gross rental yield would be 5.2% ($500 x 52 weeks / $500,000). But when you factor in the LMI cost, your net rental yield drops to 4.9% ($500 x 52 weeks / $515,000).
Understanding home loan repayments is crucial as they can significantly affect your overall profitability. Over time, as you pay down your mortgage and your property appreciates in value, the impact of LMI on your yields will reduce. But you need to factor in loan repayments when assessing an investment property.
How to Reduce LMI Costs
If you want to minimise LMI costs, here are some strategies:
- Save a bigger deposit: The more you can put upfront, the lower your LMI premium will be. Aim for at least 15-20% of the purchase price. However, consider the trade-offs between deciding to pay LMI to enter the market sooner versus saving for a larger deposit to avoid LMI altogether potentially.
- Use equity from other properties: If you already own one or more properties, you may be able to use the equity in those properties to fund your deposit and reduce or eliminate the need for LMI.
- Consider a family guarantee: Some lenders allow a family member (usually a parent) to use their property as security for part of your loan and potentially reduce or avoid LMI.
- Shop around for lenders: LMI premiums can vary between lenders, so it pays to compare your options and find the best deal.
How to Use LMIs to Build Wealth
Many successful property investors have used the insurance to grow their portfolios and build long-term wealth.
Sarah and Mark, a young couple from Melbourne, used LMI to buy their first investment property with a 10% deposit. By using the rental income to pay their mortgage and expenses, they were able to save up for a second deposit faster and grow their portfolio to three properties in five years.
Cayden, a seasoned investor from Sydney, used LMI to buy multiple properties during a market downturn when prices were lower and rental yields were higher. Despite paying LMI premiums on each property, he generated strong cash flow and benefited from capital growth as the market recovered.
What is Lenders Mortgage Insurance for Landlords vs Owner-Occupiers: What’s the difference?
While LMI works the same for landlords and owner-occupiers, there are some key differences, such as:
- Premium rates: LMI premiums are often higher for investment properties than for owner-occupied homes as lenders view them as higher risk.
- Tax deductibility: As mentioned above, landlords can claim a tax deduction for LMI premiums, while owner-occupiers can’t. It is important to note that LMI should not be confused with mortgage protection insurance (MPI). MPI protects borrowers by covering their mortgage repayments in situations such as unemployment, death, or disability, whereas LMI solely protects the lender.
- Loan products: Some lenders offer special loan products for investors, which may have different LMI thresholds or waived premiums for certain professions.
The Risks of LMI for Landlords: What to know
While LMI can be a useful tool for property investors, it’s not without risks. There are some potential downsides to be aware of, such as:
- Increased debt: Using LMI means borrowing more money, which can put you at greater risk if property values drop or there’s a loss of rent. The security property serves as collateral for the home loan and defaulting on a loan can lead to the sale of the property to cover the outstanding loan amount, potentially resulting in further financial repercussions.
- Negative equity: If your property value drops below your outstanding loan balance, you could end up owing more than the property is worth. This is called negative equity and can make it hard to sell or refinance your property.
- Cash flow strain: Paying LMI means you have less money available for other expenses or investments. Make sure you have enough cash reserves to cover any unexpected costs or vacancies.
Key Takeaways
- LMI allows landlords to buy investment properties with a smaller deposit and grow their portfolio faster.
- LMI premiums are tax deductible for landlords over the life of the loan or five years.
- LMI will impact rental yields and profitability in the short term.
- Ways to reduce LMI costs are to save a bigger deposit, use equity from existing properties and consider a family guarantee.
- LMI premiums are higher for investment properties than owner-occupied homes.
- Risks of LMI for landlords include increased debt, negative equity, and cash flow strain.
Frequently Asked Questions
Is LMI compulsory for landlords with less than 20% deposit?
Generally yes. Lenders require LMI when the LVR is above 80% (less than 20% deposit).
Who pays for the LMI? The landlord or the lender?
The cost of LMI is usually paid by the landlord (borrower) but arranged by the lender. The premium can be paid upfront or capitalised into the loan, so you’ll pay interest on it over the life of the loan.
Can I claim LMI premiums as a tax deduction?
Yes, landlords can claim LMI premiums as a tax deduction over the lesser of the life of the loan or 5 years. Keep accurate records and consult a tax pro.
Is LMI refundable if I sell my investment property or refinance my loan?
No, LMI premiums are non-refundable. Even if you sell your property or refinance your loan, you won’t get the premium back.
Are there any ways to avoid paying LMI as a landlord?
Yes, there are a few ways to potentially avoid LMI – save a bigger deposit (at least 20%), use equity from other properties, or consider a family guarantee. Some lenders also have loan products with reduced or no LMI for certain professions.