When embarking on your property ownership journey in Australia, Lender’s Mortgage Insurance (LMI) can often seem like an unwelcome and confusing additional expense. However, rather than viewing it as a hurdle, savvy borrowers are increasingly recognizing the benefits of capitalizing LMI into their home loans. Let’s explore why this strategy could be a game-changer for your property investment plans.

First, let’s clarify what LMI is. Lender’s Mortgage Insurance is a one-off premium that protects the lender if you default on your loan. It’s typically required when you’re borrowing more than 80% of the property’s value. While it’s an additional cost, LMI allows you to enter the property market sooner with a smaller deposit.

For a more detailed explanation of LMI, its costs, and how it works, you can refer to this comprehensive guide. 

The Power of Capitalization

Capitalising LMI means adding the premium to your home loan amount instead of paying it upfront. Here’s why this approach can be beneficial:

Preserve Your Savings

By capitalising LMI, you can keep more money in your pocket for other essential expenses. Moving costs, furniture, and unexpected repairs can quickly deplete your savings. Having this extra cash buffer can provide peace of mind during the crucial early stages of homeownership. If the property is an investment property then capitalising LMI can be a tax deduction while also preserving your savings for another investment property sooner. 

For instance, if your LMI premium is $10,000, capitalising it means you don’t have to pay this amount upfront, leaving you with more funds in your bank account.

Enter the Market Sooner

In rapidly growing property markets, which is almost all of the property markets within Australia, waiting to save a 20% deposit could mean missing out on potential capital gains. Capitalising LMI allows you to enter the market sooner with a smaller deposit, potentially benefiting from property value increases.

Consider a scenario where property prices are rising by 5% annually. If it takes you an extra two years to save for a 20% deposit, the $500,000 property could appreciate to $551,250. By capitalising LMI and entering the market earlier, you could benefit from this $51,250 increase in value.

Spread the Cost Over Time

Instead of a large upfront payment, capitalising LMI spreads the cost over the life of your loan. This can make the expense more manageable, especially when you’re juggling multiple costs associated with buying a property.

For example, if your LMI premium is $10,000 and you have a 30-year loan at 3.5% interest, capitalising it would add approximately $45 to your monthly repayments. This might be more manageable than finding an extra $10,000 at the time of purchase.

Potential Tax Benefits

For investment properties, the interest on your entire loan amount, including capitalised LMI, may be tax-deductible. Always consult with a tax professional to understand your specific circumstances.

This could mean additional tax deductions over the life of your loan, potentially saving you thousands of dollars depending on your tax bracket and the size of your LMI premium.

Opportunity Cost

The money you save by not paying LMI upfront could be used for property improvements, increasing your home’s value, or invested elsewhere for potentially higher returns.

For instance, you could use the $10,000 saved on upfront LMI to renovate a bathroom, potentially increasing your property’s value by $15,000 or more.

Flexibility in Property Choice

Capitalising LMI might allow you to consider properties in a higher price range, potentially opening up opportunities in better locations or for properties with more desirable features.

This could mean the difference between purchasing in a high-growth area with good schools and amenities versus settling for a less desirable location.

Easier Refinancing

If you decide to refinance in the future, having more equity in your property (from your initial deposit plus any capital growth) could put you in a stronger position.

For example, if your property value increases from $500,000 to $600,000 over five years, your loan-to-value ratio improves, potentially qualifying you for better refinancing terms.

For a more detailed explanation of loan-to-value, and how it works, you can refer to this detailed explainer article. 

Considerations and Caveats

While capitalising LMI offers numerous benefits, it’s important to consider:

  • Long-term costs: You’ll pay interest on the capitalised LMI over the life of your loan. Using the earlier example, capitalising a $10,000 LMI premium over 30 years at 3.5% interest would cost approximately $16,200 in total.
  • Loan-to-Value Ratio (LVR): Capitalising LMI will increase your LVR, which could affect your interest rate. For instance, your LVR might increase from 90% to 92%, potentially resulting in a slightly higher interest rate.
  • Property value: Ensure the property has strong potential for capital growth to offset the additional borrowed amount. Research the area’s historical growth rates and future development plans to make an informed decision.

Making an Informed Decision

The decision to capitalise LMI should be part of a broader financial strategy. Consider your long-term goals, current financial situation, and the property market conditions. It’s always wise to consult with financial professionals who can provide personalised advice.

For example, if you’re planning to hold the property for only a few years, the benefits of capitalising LMI might be outweighed by the additional interest costs. However, if you’re entering a rapidly growing market and plan to hold the property long-term, capitalising LMI could be a strategic move.

By carefully weighing the pros and cons, you can determine if capitalising LMI aligns with your financial objectives and property investment strategy. Remember, what works best for one borrower may not be ideal for another. Your decision should be based on your unique circumstances and long-term financial goals.

Capitalising LMI can be a strategic move that allows you to enter the property market sooner and manage your cash flow more effectively. However, it’s crucial to understand the long-term implications and ensure this approach aligns with your overall financial plan. With careful consideration and professional advice, you can make an informed decision that supports your journey towards property ownership and financial success in Australia’s dynamic real estate market.