The standard down payment for a home is 20 percent of the purchase price, but not everyone has that much saved up. Homebuyers typically pay for Lenders Mortgage Insurance (LMI) if they're unable to make come up with the 20 percent. The expense of LMI can be considerable, but it's often the only way for a buyer to purchase the property. See how it works, and why it actually benefits buyers in the long run.
How It Works
A bank wants to take on as little risk as possible, so they're going to reward people with more cash on hand. Meeting only the minimum down payment of 5 percent means a homeowner is going to have very little equity in the home, making it that much easier for them to abandon. LMI is designed to protect the lender in case the buyer can't meet their monthly payments. It's technically the lender's policy and not the buyers. The lender pays for the insurance and passes the costs down to the buyer.
One good thing about LMI is that it having it doesn't affect your financial standing or credit score. It also works to keep interest rates down for everyone. Once a homeowner meets the golden standard of 20 percent, they are no longer required to have LMI anymore. Buyers are encouraged to reach this number as soon as possible to save more money in the long run.
Lenders aren't just attempting to recover the price of the original loan when it comes to LMI. From depreciation to resale costs, the LMI is can be used for all expenses in the case of default payments. Real estate prices have seen some extreme swings in certain parts of Canada, and the more it rises, the more people need LMI to even consider purchasing a home.
The actual cost of LMI is based on the purchase price of the home, but it's also based on the lender and their chosen insurance carrier. Usually, LMI is 2.8–4 percent of the amount of the loan. So if a buyer puts down $10,000 on a $100,000 home, then their LMI percentage would be based on the remaining $90,000 loan. The premium can be paid on one lump sum or it can be divided into monthly contributions on top of the mortgage payments.
Benefits and Limits
The real benefit of LMI is that the risk is passed to the insurance rather than other homeowners. If there were no LMI, interest rates would inevitably have to rise to account for those who couldn't pay their mortgages. However, there are certain situations where buyers will not be able to use LMI to their advantage. Any home worth a million or more will need a 20 percent down payment in full, as will any mortgages that last longer than 25 years.
If purchasing a home between $500,000 and $999,999, buyers will need to pay at least 5 percent down on the first half a million and 10 percent of the leftover amount. So if buying a home for $750,000, the buyer will need at least $30,000 for the first $500,000 and then an additional $25,000 for the remaining $250,000.
LMI can be confusing and expensive, but it does have concrete benefits for buyers who can't come up with a 20 percent down payment. The key is to put as much money toward the home in Coventry Hills or elsewhere—as soon as humanly possible to get the best possible rates.