Puzzle Finance Blog

Mortgage insurance should be portable

Double dipping on cover hurts borrowers.

Critics say lenders' mortgage insurance is a rip-off and there is not enough competition in the industry to drive prices down. Moreover, they say insurers should be prevented from ''double dipping'' - charging borrowers again when they switch lenders for a better deal.

Though paid for by borrowers, the insurance covers lenders for the shortfall that may occur through the sale of a repossessed house.

It is virtually compulsory for anyone buying property with less than a 20 per cent deposit. But the default rates, even among first-home buyers, are small.

The market is dominated by just two businesses - Genworth Financial and QBE Lenders' Mortgage Insurance. When Genworth Financial's American parent floats up to 40 per cent of its Australian mortgage insurance business on the Australian sharemarket this year, demand for the shares is expected to be strong.

There's little doubt it's a highly profitable business. But what does it mean for home loan borrowers?

High cost

About 90 per cent of first-home buyers around the country pay up to thousands of dollars to buy the insurance.

The calculator on the Genworth website shows that someone with a $15,000 deposit on a $300,000 house (a deposit of 5 per cent) would pay slightly more than $6000, including the NSW stamp duty of $53.

While it is a one-off premium, most lenders capitalise the premium on to the mortgage.

If this premium were added to the loan, the extra monthly repayment would be $50 a month, which, Genworth says, is ''only one takeaway coffee a day''.

However, that is calculated on a 30-year loan term.

Should the borrower think of switching loans, that expense will arise again.

Disclosure about what the insurance is and how it works is, at best, patchy.

Some borrowers confuse it with mortgage protection insurance, which covers them for the payment of their mortgage instalments for a limited period in the event of illness, injury or unemployment.

Barrier to switching

The mortgage insurance providers argue that without it, many home buyers with less than 20 per cent would not qualify for a mortgage. Lenders would simply not take on the risk of lending to those with small deposits unless they were covered by insurance.

They also argue that lenders' mortgage insurance reduces the interest rate that borrowers with a deposit of less than 20 per cent would have to pay to compensate lenders for the extra risk they are taking. And even if default rates are low, the insurance is a safety net that would help to protect the banking system if there were a crisis in the housing market.

No one is arguing that lenders' mortgage insurance is not valuable. The argument is over how much borrowers are paying for it and that the insurance is not portable. Some lenders do give a rebate to borrowers if they switch after 18 months or two years.

However, even then, the borrower usually has to ask for it and the rebate is unlikely to be more than 50 per cent of the premium, says the national president of the Finance Brokers Association of Australia, Peter White.

''If the LMI is cancelled two or three years later, why is the borrower not entitled to a proportional rebate, like what would happen with a car insurer?'' he asks.

The cost of lenders' mortgage insurance when switching lenders can be a bigger financial impediment to switching lenders than mortgage exit fees, White says.

Case for portability

The chief executive of RateCity, Damian Smith, agrees that lenders' mortgage insurance is a barrier to switching loan provider.

''If you look at the list of things that are financial barriers to switching from one lender to another, it's hard to find anything bigger than lenders' mortgage insurance on that list,'' he says.

There appears to be only one way - apart from saving a deposit of more than 20 per cent - that borrowers can avoid paying the insurance premium.

ANZ, for example, has its ''Family Guarantee'', which allows certain family members to use the equity in their home as additional security for a portion of the loan amount.

Of course, if there is a default the guarantor can be financially liable.

The head of campaigns at Choice, Matt Levey, says the consumer group would like to see change: ''We think there is a case for a root-and-branch look at this issue.

''We have a situation where consumers are forced to take out a form of insurance that is not insuring them but insuring their lender against them defaulting.

''At face value it looks like an uncompetitive market, dominated by a small number of players, with little consumer choice.''

When shopping around for a mortgage, home buyers have to look at more than the interest rate, Levey says.

They need to be also looking at the premium they are paying for the lenders' mortgage insurance and what the lenders' rebate policy is, if any, before signing up.

''People should not assume that it [the insurance premium] is a fair cop,'' he says. ''They need to ask some questions.'' Better disclosure

THE government introduced reforms last year aimed at making it easier for borrowers to switch financial institutions, as part of its efforts to increase competition in the banking sector.

The key reform was the banning of exit fees on new mortgages taken out from July 1 last year.

Also last year, when Treasurer Wayne Swan announced further reforms to enhance competition, he said the government would not force insurers to have lenders' mortgage insurance follow the borrower when they refinance. Swan said the Treasury had advised the government it would be ''expensive, extremely complex to implement and administer and would likely benefit less than 1 per cent of all borrowers''.

Instead, probably from July 1 this year, lenders will have to issue a one-page ''fact sheet'' on lenders' mortgage insurance to help consumers understand the costs and benefits of lenders' mortgage insurance when they take out a home loan.

Matt Levey, of consumer group Choice, says disclosure on its own is not enough.

''If the argument is that portability is too complex, then let's have the argument,'' he says.

Posted by John Collett - The Age on 3rd March, 2012 | Comments | Trackbacks

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