Insurance: Lenders mortgage insurance

By John Grant When you borrow large sums of money, the lender will assess the risks of you defaulting on part or all of the loan. Normally they hold a general provision for defaults. In the case of residential mortgages however, these 'provisions' can be replaced by Lenders Mortgage Insurance (LMI). Lenders provide for bad debts and have many ways of estimating what potential losses they may experience on their mortgage portfolio. The amounts provided reduces their potential returns, and we have seen the emergence of specialist insurance schemes allowing a lender to insure the risk of default by borrowers. This can either be done for an individual loan, or for whole mortgage portfolios insured as a single risk. This is a way for lenders to minimise the risk of potential losses. By insuring, a lender is unlikely to have to provide any more for losses, or nowhere near the same extent as a non insured loan. Mortgage insurance is a specialised field, and in New Zealand there are only two providers: Genworth Mortgage Insurance, and QBE Lenders Mortgage Insurance (previously known as PMI until it was acquired by QBE in 2008). The largest volume of business for mortgage insurers was found in the 'non-bank' sector. Since the financial crisis most of these lenders have vanished and this has resulted in the LMI companies significantly scaling back their operations. Who pays for lenders mortgage insurance? The policy is between the lender and the insurer so the responsibility for premium payment rests with the lender. However, in nearly all cases the lender will seek payment from the borrower. In fact, it will be a condition of the loan that the borrower will pay (reimburse) the premium cost. How much does it cost? On a standard loan of less than $500,000 where the amount borrowed is less than 80% of the value of the property, and where full financials have been provided, then a premium will usually be less than $250. However, on higher loan-to-value-ratio's, the premium rates increase and could be as high as 4% of the amount borrowed. The premiums is paid once only, at the time the loan is granted and first drawn. In most cases a refund can be applied for if the loan terminates before the completion of an initial term which varies according to individual contracts but is generally 3 years. Recovery by mortgage insurers Mortgage insurers actively seek to recover the amounts they pay in claims. This means that if the borrower has not been able to repay the full amount, they will receive contact from the LMI company seeking recovery of the amount of shortfall plus costs and interest. Adds complications to negotiations If a borrower is having problems making loan payments and seeks approval to sell a property where a shortfall will occur then it will be the LMI company giving the final ok's and not the lender. But in almost all cases the borrower will have to negotiate through the lender who will in turn take the case to the LMI company for final approval. This can create a complex situation - and our earlier story on insurers and the rights you give them under a policy is sort of relevant here. While this is not identical, in this instance it's actually the lender who has assigned their rights. Lenders mortgage insurance adds additional cost and complication to a loan, but on the other hand they are the price you pay if you can't get a loan from a mainstream bank lender. Therefore know what you are getting into and be prepared for a potentially more complex arrangement.