It’s becoming harder for Australians to avoid the added cost of mortgage insurance when they negotiate home loans. Not everyone has the financial wherewithal to scrape together a 20 per cent deposit, especially when one-bedroom apartments in inner-city areas come with $500,000 price tags, and a basic house-and-land package in an outer suburb can set you back $450,000.

Lenders’ mortgage insurance (LMI) is usually charged by a lender when borrowings exceed 80 per cent of a property’s value.

LMI protects the lender against a loss should you default on your loan, and it doesn’t come cheap.

A big provider of mortgage insurance, Genworth Financial, gives on its website the example of a couple who have a $20,000 deposit and are buying a new home worth $400,000. The LMI premium on their $380,000 loan comes to $12,426, according to Genworth, which is owned by General Electric.

The cost of LMI varies depending on the loan amount, the level of equity in the security property and the level of risk associated with the type of loan product you select. Investors tend to pay slightly higher LMI premiums than owner-occupiers because investors have a worse record of defaulting on loans.

Belinda Williamson, the spokeswoman for mortgage broker group Mortgage Choice, says the cost of LMI premiums are tiered according to a borrower’s loan-to-value ratio (LVR). ”The higher the LVR, the higher the premium,” she says.

The reason why mortgage insurance is cheaper if you borrow 82 per cent of a property’s value rather than 95 per cent is because the insurer’s risk of loss is sharply reduced with an 82/18 LVR. Before jumping in, it pays to review your deposit amount and weigh the pros and cons of saving a larger deposit.

Ms Williamson says borrowers should ask lenders whether the LMI can be capitalised into a loan and paid down over time. Some insurers allow the full premium to be capitalised. Others will capitalise only a portion.

You need to tread carefully. It isn’t possible to shop for another insurer outside your chosen lender’s LMI provider. It makes sense, therefore, to select a lender that offers a ”panel” of LMI providers, rather than the closed shop of a single provider.

The high cost of LMI is a colossal drag on the first-home buyer market. The managing director of builder Boutique Homes, Aidan Hooper, says since 1989 successive West Australian governments have effectively insured the loans of first-home buyers at no cost to the buyer. WA’s Keystart scheme assists young buyers to get into a first home and needs to be replicated in other states, he says.

A deposit of just $10,000 is all that’s needed to buy a first home under Keystart. ”There is no mortgage insurance at all,” Mr Hooper says. ”It is guaranteed by the government, so if you are a first-home buyer and you default after two or three years the government would pick up the tab.”

For owner-occupiers in Victoria, the sensible strategy is to save a bigger deposit and avoid mortgage insurance because you won’t be able to write off your insurance costs against tax. But for investors, who can claim for mortgage insurance, the issue is not so black and white.

While it protects the lender if you stop making mortgage payments, LMI also makes it possible to buy more properties with small deposits. Provided you do your homework, that can work to your advantage.

Posted by Chris Tolhurst – The Age on 23rd March, 2013