What is mortgage insurance and how does it work?

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There are two main types of mortgage insurance – mortgage repayment protection insurance and lenders’ mortgage insurance. The first is similar to the other types of personal insurance, like life cover and income protection, so this article is mainly focused on lenders’ mortgage insurance.

What is mortgage protection insurance?

This is a form of income protection insurance for people who have a mortgage. It’s usually optional and provides peace of mind, because your mortgage repayments will be covered if you become unemployed, disabled or unwell for an extended period. It can also provide cover for your partner if you die, so they can still afford mortgage payments and continue living in the family home.

The waiting period before insurance benefit payments start and how long they continue for can usually be varied to suit your needs. These things, along with the size of your mortgage repayments, will affect the cost of your insurance premium.

What is lenders’ mortgage insurance?

Lenders’ mortgage insurance (LMI) protects the lender from the risk of you defaulting on your mortgage repayments. If you can no longer afford your mortgage payments, the lender might have to sell your home to recover what they’re owed. If you have a low deposit mortgage and still owe most of what you borrowed, the sale price might not cover the remaining balance. This is more likely to occur if house prices have fallen, which sometimes happens in challenging economic times, periods of high unemployment or when interest rates are high. The problem is, all three of these conditions can also make it more difficult for home owners with large mortgages to continue meeting their regular mortgage repayments.

To reduce their risk of losing money, the lender charges a higher interest rate than normal on low deposit home loans. For this reason, lenders’ mortgage insurance is often called a ‘low equity margin’ (LEM) or ‘low equity premium’ (LEP). In other words, you pay a premium above the usual interest rate because you don’t have much equity (value above what you owe) in your home. That higher interest rate is taken into account when the lender calculates the regular mortgage repayments you can reasonably afford and the amount they can responsibly lend to you.

Some lenders offer an alternative option. Instead of paying a higher interest rate, they add a lump sum onto the amount you owe. For a $500,000 mortgage this could be around $1,500 if you’re borrowing 81-85% of the home’s value, or as high as $10,000 for a 95% loan-to-value ratio (LVR). Again, this additional amount is taken into account when the lender calculates how much they can responsibly lend to you, based on your ability to meet the regular repayments.

While simply adding the extra onto your mortgage may seem an easier option, it’s important to realise you will pay interest on that extra amount for the life of your loan. Essentially, it will be the last amount you repay.

To explore the effects of borrowing more or paying a slightly higher interest rate, see our handy mortgage repayments calculator.

When does lenders’ mortgage insurance apply?

You’ll normally have to pay for LMI when your house deposit is less than 20% of the property’s value. Responsible lending regulations, introduced by the government through the Reserve Bank towards the end of 2021, have made it much harder to get a mortgage with a deposit that’s less than 20%, unless you’re a first home buyer. The smaller your deposit, the higher your LMI rate.

What does lenders’ mortgage insurance cost?

If lenders’ mortgage insurance is charged as a low equity premium on the interest rate, the extra will typically be between 0.25% and 1.25% p.a. depending on your deposit. However, it can be as high as 2%.

Each lender sets its own margins, but the scale might look something like this one from BNZ at 2/12/21:

DepositLoan-to-value ratio (LVR)Low equity premium/margin
19.99% - 15%80.01% - 85%0.35% p.a.
14.99% - 10%85.01% - 90%0.75% p.a.
9.99% - 5%90.01% - 95%1.00% p.a.
Less than 5%More than 95%1.15% p.a.

If the LMI is charged as a one-off fee that’s added to your mortgage, it will typically be between 0.25% and 2.00% of the loan amount.

The scale might look something like this one from ANZ at 2/12/21:

DepositLoan-to-value ratio (LVR)Low equity premium/margin
19.99% - 15%80.01% - 85%0.25% of loan amount
14.99% - 10%85.01% - 90%0.75% of loan amount
Less than 10%More than 90%2.00% of loan amount

Most lenders offer special low interest deals, but these are only available for deposits of 20% or more. If you don’t have a 20% deposit you’ll probably have to pay one of the higher standard rates, with lenders’ mortgage insurance on top of that.

It’s important to get independent professional advice from an accountant or lawyer before signing up to any mortgage, particularly one with LMI payments. It also pays to shop around as each lender has its own rates and rules. Mortgage brokers, also known as mortgage advisors, can often help you find the best deals for your situation.

Does lenders’ mortgage insurance apply to a First Home Loan?

As the name suggests, First Home Loans are for first home buyers who meet eligibility rules set by the crown entity Kāinga Ora. The rules include an income cap and maximum house prices for each region in New Zealand.

The good news is, First Home Loans only require a 5% deposit (95% LVR). And because they’re underwritten by Kāinga Ora, the lenders’ mortgage insurance is only 1.00% of the loan value. This one-off fee can simply be added to your mortgage.

First Home Loans are only available through participating lenders, such as Westpac, Kiwibank, The Cooperative Bank, SBS bank and several credit unions. Each lender has its own lending criteria and interest rates. After checking you meet the Kāinga Ora First Home Loan criteria, you can apply through any of the participating lenders.

The Kāinga Ora website has more on First Home Loans.

Avoiding LMI costs once your home increases in value

Over time, you’ll repay some of what you initially borrowed and your home may increase in value. Before long, you could find the equity you have in your property is more than 20% of its value. If so, you can ask your lender to re-negotiate your mortgage as a standard home loan, without the cost of lenders’ mortgage insurance. You may also be able to get an interest rate special. If you’re on a fixed interest rate, you may have to wait until the end of the interest rate term before refinancing to a mortgage without LMI.

To learn more:

DISCLAIMER: The information contained in this article is general in nature. While facts have been checked, the article does not constitute a financial advice service. The article is only intended to provide education about the New Zealand mortgages and home loans sector. Nothing in this article constitutes a recommendation that any strategy, loan type or mortgage-related service is suitable for any specific person. We cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you. Before making financial decisions, we highly recommend you seek professional advice from someone who is authorised to provide financial advice.

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