Mortgage insurance is one of the most misunderstood terms when it comes to home loans. Its correct title is Lenders Mortgage Insurance. In other words, this is an insurance policy which covers the lender’s, not the borrower’s, liabilities.
Let’s look at what happens.
Whenever a bank lends more than 80% of the value of a property, it wants to safeguard its position. It does this by insuring the loan. It purchases the insurance product from a specialist insurance company called a Lenders Mortgage Insurer, and then it charges the borrower for the cost of that insurance policy.
The reason that banks take this mortgage life insurance leads approach is that over the last 30 or more years they have seen that the greatest numbers of loan defaults occur when they approve highly geared loans, particularly those above 80%.
By having an insurance policy such as this in place, a bank is more comfortable about making these loans available to its customers and so a greater number of people can realise the great Australian dream.
The insurance policy will only cover the bank for the first couple of years and simply means that if a loan goes into default and the property has to be sold, the bank is guaranteed to get its money back in the event that the house sale does not cover the loan amount.
The banks maintain that they should not be taking this risk by themselves, and that’s why borrowers are charged for the insurance policy.
A significant point about mortgage insurance is that it is the most expensive individual item involved in most home loan transactions. When a bank lends 95% of the value of the house the insurance premium can be close to 3% of the loan amount. This means that for a home loan of $300,000, the premium could be close to $9,000. The rule of thumb is that the higher the loan to value ratio, the higher percentage the lenders mortgage insurance premium charge will be. The increase occurs at an exponential rate.
One final point to remember here is that if you have had to pay a mortgage insurance premium, and you sell your house within 2 years, you should check with your lender to see if there’s any refund on the premium. If so any refund is payable to you, not the bank. But, you won’t get this unless you ask for it!