In this article the topic of discussion will be Mortgage Insurance. We will define what mortgage insurance is? How it relates to specific mortgage transactions? and how it is calculated generally?

What is Mortgage Insurance?

One of the biggest misconceptions about mortgage insurance I come across when I talk to customers is that it is a policy which protects borrowers. Mortgage Insurance is actually quite the contrary and was essentially developed to protect the lender not the borrower.

When a borrower has failed to make the repayments on their mortgage for a specific length of time the lender will make a claim with the nominated mortgage insurer to recover loss of funds ( only applies to mortgage insured facilities). This loss can be represented by the failure to pay mortgage repayments or a loss due to the lender not being able to recover the outstanding debt from the sale of the borrower’s property. The economical loss suffered by the lender would be paid by the mortgage insurer and then an attempt would be made by the insurer to recover funds from the borrower.

In what situation(s) is mortgage insurance applicable?

Mortgage Insurance is specifically applied to residential mortgage facilities. There are generally two core mortgage product policies in which mortgage insurance is applied to.

The first product policy is full documentation loans whereby the applicant can verify their income and they wish to borrow more than 80% of a property’s market value. To keep it simple an example would be, if I was to borrow $90,000 against a property worth $100,000, this would be equivalent to borrowing 90% of the property’s market value which would mean a mortgage insurance premium would be payable/applicable.

The second product policy mortgage insurance applies to is low documentation or low doc loans specifically for self employed borrowers who cannot verify their income via traditional methods and wish to borrow more than 60% of a property’s market value.

Mortgage insurance can vary from lender to lender and the way it is calculated and paid for can also differ in many ways. There are two major Mortgage Insurers in Australia GE & QBE PMI. These two larger insurers are used by a majority of lenders for all mortgage insured residential lending facilities. There are a few smaller mortgage insurers which are solely lender based. For example WLMI is the exclusive in house mortgage insurer for Westpac and SGMI is the in house select mortgage insurer for St George.

How is the mortgage insurance premium calculated?

Each mortgage insurer’s policies are different to one another’s and so are the overall premiums charged to their lenders and accordingly to their borrowers.

The premium for mortgage insurance is calculated by taking into account a number of elements. The major components include, the total loan amount, the loan to valuation ratio, the degree of genuine savings, the percentage of existing equity in property, the location of the property being used as security and the mortgage product policy type, be it a full document or low document mortgage.

So what are the advantages of mortgage insurance?

You may be asking yourself, so what are the advantages of mortgage insurance if I am ending up paying for the premium and the lender is getting all the protection? We’ll in a way you’re right but the true advantage to the borrower is > leverage. Mortgage Insurance allows the borrower to borrow more against the market value of a property (above 80% LVR full document mortgages and above 60% LVR for low document mortgages).

For example if you found your dream home and only had a 5% deposit to put towards your purchase the lender you have chosen may only allow you to borrow up to a total of 80% of the market value of that property. If however you mortgage insure your loan you may be able to borrow up to 95% of the market value of that property. This is an increase of up to 15% extra, to help you fund your dream home (with the catch of paying a mortgage insurance premium).

Mortgage Insurance gives borrowers an opportunity to leverage and to make the transaction happen when the lender solely would not take on any more mortgage risk (e.g. lender max. risk 80% LVR and mortgage insurer maximum risk 95% LVR).

What are the different methods a mortgage insurance premium can be paid?

Mortgage Insurance can be paid in a variety of ways. This will ultimately depend on your lender, the mortgage product selected and the mortgage insurer. There are generally four different payment methods:

1. The standard method of payment is to give authority to your nominated lender to deduct the premium off the total loan applied for. For example if you were to borrow $200,000 and your mortgage insurance premium was $3,000, your total loan will still be $200,000 but your available funds at settlement will only be equal to $197,000 taking into account the $3,000 premium expense.

2. Another way you can pay for the mortgage insurance premium is from your cash savings. You can nominate to your lender to debit your savings or credit account for the total premium amount or pay it into a nominated account allocated by your lender at settlement.
   

3. Adding the total mortgage insurance premium to you nominated loan is also an option that is available. This process is called mortgage insurance capitalisation. An example of this would be opting to add your total premium of $3,000 to your loan amount of $200,000 giving you a total loan of $203,000. The primary advantage of this option is that you would be able to reserve more cash in savings by borrowing the premium. On the other hand the disadvantage would be paying interest on the premium on top of the interest your paying on your initial loan amount.
   

4. The least common method which is only available through certain lenders is the amortisation or loading of the interest rate to cover the mortgage insurance premium. In this scenario if you applied for a $200,000 mortgage and your indicative interest rate was say 6.00% you may be paying an additional 0.25 of a percent on top of your standard interest rate to cover the mortgage insurance premium. The only negative element of this method is when your premium is paid in full over a 3 or 4 year period your rate still remains loaded by that specific amount that covered the initial mortgage insurance premium.

For an indicative mortgage insurance premium calculation please email info@whygroup.com.au or call 1300 275 949.

Although I have covered a fair bit about mortgage insurance in this article there is still a-lot of information which we haven’t covered. It really is very important you understand how mortgage insurance works, the advantages and disadvantages of different policies and how it may assist or effect your personal circumstances.

In the meantime if you’re not 100% sure about anything or if you have any questions please call 1300 275 949.

Petros Arvanitis is a specialist mortgage planner who has helped hundreds of Australian’s rebuild their credit, lower their repayments and plan for a brighter future. He is the founder of Why Group, providing Australians with a simple and fresh approach to financial services.