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The pitfalls of no deposit home loans

The pitfalls of no deposit home loans

No deposit home loans are pretty much a thing of the past, however you can still get your foot on to the property ladder with little or no deposit, if you play your cards right.

There’s no question, low deposit home loans are handy, particularly if you need to buy a property in a rush and you haven’t had time to save up enough money.  And while lenders are really cracking down on people who don’t have a decent deposit, there are options available:

1. Find a guarantor

Getting a family member to guarantor your loan is one way to get the keys to your first place without a deposit. It does come with risks however, especially if you can’t meet your monthly repayments so do some research on what’s involved so you can make an informed decision. Before you sign the dotted line, use a mortgage calculator to make sure you can meet the repayments, even if interest rates rise by 2, 3 or even 4 per cent, which is an entirely likely scenario over the course of the average home loan.

2. Use equity from another property

If you already the proud owner of another property, one option could be to borrow against the equity in that home.  The best place to start is to talk to your existing lender, or a financial adviser to find out how much you can draw from it.

3. Save up for a 3 per cent deposit

While its not ideal, some lenders will allow you to borrow 95 per cent of the property’s purchase price – or even 97 per cent if you include the LMI you’ll be required to pay as part of your loan, which means you’ll only have to come up with 3 per cent of the total cost. These products are harder to come by and most will have higher interest rates attached, so weigh up your options by comparing interest rates online.

Having genuine savings in your account is the key to securing home loan approval. Not only will it take the pressure off adjusting to making your mortgage repayments, but it will drastically help you save on interest costs. However, if you still decide to take the plunge with help from a family member, or with a very small deposit, there are a couple of downsides to low or no deposit home loans that it is important to be across:

1. Higher interest rates

Many lenders will charge you a premium for the luxury of a small deposit. In fact, as a general rule, the bigger the deposit you have, the lower your rate will be. The cheapest home loan rates on RateCity require loan to value ratios of 70 or 80 per cent, which means you’ll need a 20 – 30 per cent deposit before you can unlock the best rates.

2. Lenders Mortgage Insurance

Lenders mortgage insurance (LMI) often comes as an unexpected (and unwelcome) surprise when you finalise your home loan, but only if your deposit is less than 20 per cent of the purchase price. Anyone with a loan to value ratio (LVR) of under 80 per cent, gets out of paying this expensive extra.

LMI is generally about 2 – 3 per cent of the purchase price of your property but it also depends on how large your deposit is, so if you are scraping through on the bare minimum, expect to pay over $10,000 in insurance, even for a reasonably priced property. Also be aware that while having an extra bit of insurance sounds like a fairly sensible thing to have, LMI is actually there to cover your lender, not you.  To find out more about LMI, visit the Insurance Council of Australia’s site.

3. Less borrowing power

The smaller your deposit, the less you’ll be able to borrow, even if you have a stable job and a decent salary coming in each month.  That’s because banks typically see people with no savings as risky.  If your finances go through a rough patch, or you get unexpectedly retrenched, then the bank will know you don’t have any spare cash to fall back.

To secure your dream home today, compare home loans, crunch the numbers using our repayment calculator and follow our news articles to get the latest home loan tips. For more information visit our detailed home loans guide or check out ASIC’s MoneySmart home loans fact sheet and checklist.

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