The expanded first home buyer loan guarantee scheme has failed to achieve its goals, the Insurance Council of Australia says.

Instead, it has caused “significant disruption” to the insurance industry, affected economic productivity and indirectly raised the risk of mortgage stress, according to the peak body.

Last October, the government changed the scheme’s application criteria so more first-time buyers with only 5% deposits could obtain home loans without lenders’ mortgage insurance.

“LMI gives lenders confidence to lend to households at higher [loan to value ratios] ... Lenders’ mortgage insurers provide investment elsewhere through the economy,” an ICA submission to the Senate Select Committee on Productivity said.

“We are concerned that government policy is directly contributing to the significant disruption of an otherwise productive industry that plays an important role in housing market transactions, as well as second-order productivity and financial resilience implications for some households and the broader economy.”

The industry has long raised concerns over changes to the loan guarantee scheme, which removes the need for first-time buyers to take out LMI if they do not have a 20% deposit.

Related article: Home loan scheme to push up prices, punish low earners – ICA

Lenders typically require LMI when there is a loan to value ratio of 80% or more.

“LMI protects the lender for the life of the loan and for the entire value of the loan. By mitigating mortgage lending risk, LMI helps lenders extend credit more confidently, supporting housing market activity, financial stability and ultimately long-term economic productivity,” the submission said.

“By comparison, the scheme is not an insurance product. The scheme transfers risk from specialist risk-bearers to taxpayers, shifting risk to the public balance sheet, meaning taxpayers ultimately bear losses associated with housing market downturns.”

The submission says modelling by Lateral Economics suggests guaranteeing about 590,000 mortgages by 2030 could expose the government to up to $62 billion in contingent liabilities.

“With Australia’s housing market showing signs it may be softening, first home buyers who used the expanded scheme and bought at record-high prices may be at risk of negative equity,” the submission said.

“Additionally, in a difficult macroeconomic environment, these households are increasingly likely to be subject to sustained, elevated interest rates on top of the historically high property prices at which they bought. The outcome of this combination is increased mortgage stress.”