When you're in the process of securing a home loan, particularly if you have less than a 20% deposit, you'll likely encounter terms like Low Equity Margins (LEMs) and Low Equity Premiums (LEPs). These additional fees are important to understand, as they affect the overall cost of your mortgage and how much you’ll be paying over time. In this article, we’ll break down what LEMs and LEPs are, how they work, and what you need to consider when they apply to your mortgage.
What Are Low Equity Margins (LEM)?
A Low Equity Margin (LEM) is an additional margin that a bank adds to your interest rate when you borrow with less than a 20% deposit. This margin compensates the bank for the increased risk of lending to someone with a lower loan-to-value ratio (LVR).
The amount of the margin typically depends on the size of your deposit. Here’s a basic breakdown:
10% deposit: If your deposit is around 10%, your interest rate could have a margin of approximately 0.75% added to it. This margin applies for a fixed period, often for 6, 12, or 24 months.
15% deposit: If your deposit is between 15% and 20%, the margin tends to be lower, typically around 0.25% added to your interest rate.
These margins stay in place until you have enough equity in the property to reduce the bank’s lending risk—usually when you reach 20% equity in your home.
What Are Low Equity Premiums (LEP)?
A Low Equity Premium (LEP) is different from a Low Equity Margin in that it’s an upfront fee. Instead of adding a margin to your interest rate, the bank charges you a percentage of your loan amount as a one-time fee. This fee typically sits at around 0.75% of your total loan amount.
For many borrowers, this fee ranges from about $4,000 to $7,000, depending on the size of the loan. Unlike Low Equity Margins, which are removed once you reach 20% equity, the LEP is a one-off fee and is non-refundable.
How Do LEMs and LEPs Work?
Both LEMs and LEPs are charged when your deposit is below 20%, but they work in different ways:
Low Equity Margin (LEM): An ongoing additional margin added to your interest rate until you have 20% equity.
Low Equity Premium (LEP): A one-off, upfront fee charged when your deposit is below 20%, based on the amount you’re borrowing.
How Can You Remove a Low Equity Margin?
The good news is that Low Equity Margins are not permanent. Once you have at least 20% equity in your property, you can apply to have the margin removed. There are a few ways you might build up your equity:
Paying Off Your Loan: By making regular or extra repayments, you can reduce your loan amount and increase your equity.
Capital Growth: If the value of your home increases due to market conditions or improvements you’ve made, you might have gained enough equity without reducing your loan balance.
Lump-Sum Payment: If you receive a lump sum from an inheritance, a bonus, or other sources, you could use that money to reduce your mortgage and improve your equity.
To prove that you’ve reached 20% equity, the bank will often require an updated registered valuation of the property. This valuation will show whether the combination of your loan balance and your property’s value meets the 20% threshold.
Lender’s Mortgage Insurance (LMI)
If you’re a first home buyer using a government-backed first home loan, you might also encounter Lender’s Mortgage Insurance (LMI). This is another form of insurance that protects the lender when you have a low deposit. Like a Low Equity Premium, it’s an upfront fee and is typically charged at a similar percentage of the loan amount. This fee is usually added to your loan balance.
When Should You Consider Paying a Low Equity Premium or Margin?
Whether you’re dealing with a Low Equity Margin or a Low Equity Premium, the key thing to remember is that these fees are a reflection of the bank’s risk. If you’re borrowing with less than a 20% deposit, these costs are common. However, understanding the difference between paying an upfront premium versus dealing with a margin on your interest rate can help you decide what works best for your financial situation.
For some borrowers, paying an upfront Low Equity Premium might be more convenient than having a higher interest rate for a fixed period. For others, dealing with the additional interest margin may make more sense, especially if they expect to reach 20% equity relatively quickly through repayments or home value growth.
The Importance of Personalised Advice
Given the complexity of these additional fees and how they affect your mortgage, it’s essential to get advice tailored to your specific situation. Every borrower is different, and the right choice for you will depend on your financial goals, your loan-to-value ratio, and how long you expect to have less than 20% equity in your property.
If you’re unsure about how LEMs or LEPs will affect your home loan, or if you want to explore options for removing them, it’s a good idea to consult with a mortgage advisor. At My Mortgage, we can provide expert guidance and help you navigate the best options for your loan.
Conclusion
Low Equity Margins (LEMs) and Low Equity Premiums (LEPs) are important considerations when buying a home with less than a 20% deposit. Understanding how they work and what impact they have on your mortgage can save you money and help you make informed decisions. If you’re looking for advice on managing your home loan or figuring out the best way to structure it, contact us at My Mortgage. We’re here to help you on your journey to homeownership.
For more information, visit mymortgage.co.nz or get in touch with one of our advisors today.