Securing a home loan can be a daunting task, especially if you have a bad credit history. One of the crucial factors that come into play when dealing with bad credit home loans in Australia is mortgage insurance. If you’re struggling with a low credit score, understanding mortgage insurance and its impact on your loan application can significantly improve your chances of securing financing. In this article, we’ll break down everything you need to know about mortgage insurance, its role in bad credit home loans, and how to manage its costs.
What is Mortgage Insurance?
Mortgage insurance is a type of insurance designed to protect the lender in case a borrower defaults on their loan. In Australia, the most common form of mortgage insurance is Lenders Mortgage Insurance (LMI). Unlike personal insurance, LMI does not protect you as the borrower; instead, it shields the lender from financial loss if you fail to meet your mortgage obligations.
Mortgage insurance is often required when the borrower has a deposit of less than 20% of the property’s purchase price. However, it can become even more essential when the borrower has a bad credit history, as lenders view such loans as high-risk.
Why is Mortgage Insurance Important for Bad Credit Home Loans?
When you have a low credit score, lenders may be hesitant to approve your loan application because of the perceived risk that you might default on repayments. This is where mortgage insurance comes into play. By taking out mortgage insurance, the lender’s risk is reduced, making it more likely for them to approve your loan.
For bad credit borrowers, mortgage insurance is often mandatory because their creditworthiness doesn’t meet the lender’s standard requirements. LMI helps make home loans more accessible to individuals who otherwise might not qualify due to their credit history.
Lenders Mortgage Insurance (LMI) and Its Role in Bad Credit Loans
Lenders Mortgage Insurance, commonly referred to as LMI, is a vital tool for borrowers with bad credit. It enables individuals with less-than-perfect credit scores to enter the property market by allowing lenders to mitigate risk.
Here’s how LMI works: if you have a low deposit (usually less than 20% of the property’s value) or a bad credit score, the lender will require you to pay for LMI. The cost of this insurance can either be paid upfront or added to your loan amount, depending on the lender’s terms. This means that while the loan may cost you more in the long term due to higher repayments, you still have a chance to secure a mortgage.
How Does LMI Differ for Bad Credit Borrowers?
For borrowers with bad credit, the cost of LMI is generally higher than it would be for someone with good credit and a larger deposit. This is because the lender is taking on more risk by approving your loan. The exact cost of LMI depends on several factors, including:
- The size of your deposit.
- The value of the property.
- Your credit score.
Typically, the lower your deposit and the worse your credit, the higher your LMI premium will be.
Example:
If you’re purchasing a property worth $500,000 with a deposit of 10%, and you have a credit score of 550, your LMI premium might be significantly higher than someone with a 20% deposit and a credit score of 700. This extra cost is added to your loan repayments, making it important to fully understand its financial implications before proceeding.
How to Lower Mortgage Insurance Costs with Bad Credit
Although LMI is often a necessary part of obtaining a home loan with bad credit, there are strategies you can use to reduce its impact:
Even small improvements in your credit score can reduce the risk profile of your loan, which in turn could lower your LMI premiums. Paying off outstanding debts, correcting any errors on your credit report, and ensuring timely payments on all bills can help boost your score.
2. Save a Larger Deposit
The more you can save toward your deposit, the lower your Loan to Value Ratio (LVR) will be. Lenders typically require LMI when the LVR exceeds 80%, so by saving more upfront, you might be able to avoid LMI altogether or at least reduce the premium.
3. Shop Around for Lenders
Different lenders have different policies when it comes to LMI. Some lenders may offer better rates or more flexible options for borrowers with bad credit, so it’s worth comparing your options. Freedom Loans can help connect you with lenders who understand your situation and are willing to work with you.
In some cases, lenders may be willing to absorb part or all of the LMI cost, particularly if you’re able to demonstrate that your credit situation is improving. It never hurts to ask!
Alternatives to Mortgage Insurance for Bad Credit Home Loans
If mortgage insurance seems too costly or burdensome, there are alternative routes you can explore:
1. Loan Guarantor
A guarantor can help you avoid paying LMI by using their own property as additional security for your loan. This reduces the lender’s risk and can eliminate the need for LMI, though it’s a big responsibility for the guarantor.
2. Government Assistance Programs
Certain government schemes, such as the First Home Loan Deposit Scheme (FHLDS), allow eligible buyers to purchase a home with as little as 5% deposit without paying LMI. While these programs are typically aimed at first-home buyers, they can be a good option for those who qualify.
Key Considerations Before Taking on Mortgage Insurance with Bad Credit
While mortgage insurance can help you secure a home loan, it’s essential to be fully aware of its implications:
- Cost: Mortgage insurance increases your overall borrowing costs, as the premium is often added to your loan, resulting in higher repayments.
- Non-refundable: LMI is non-refundable, so if you decide to refinance or pay off your loan early, you won’t get the premium back.
- Long-term Impact: A higher loan amount due to LMI can result in a longer repayment period, potentially increasing the total interest paid over the life of the loan.
Before agreeing to pay for mortgage insurance, it’s crucial to speak with a mortgage professional to fully understand the costs and benefits, especially in the context of your credit history.
Conclusion
For borrowers with bad credit, mortgage insurance can be both a burden and a gateway to homeownership. By understanding how it works and exploring ways to reduce its cost, you can make an informed decision about whether a bad credit home loan is right for you. While Lenders Mortgage Insurance may raise the overall cost of your loan, it can also open doors to homeownership that might otherwise remain closed.
At Freedom Loans, we specialise in helping Australians with bad credit secure home loans. Our team works with a wide range of lenders to find the best solution for your unique situation. Contact us today to explore your options and take the first step toward owning your home.
1300 364 751