Three mistakes that home buyers make

While it’s possible to take out a home loan with a less than 20 per cent deposit, doing so may lead to higher interest charges and have you on the hook for Lenders Mortgage Insurance (LMI), because you’re borrowing more from your lender.

LMI is an insurance policy protecting the lender from financial loss if you fail to make your repayments. Most lenders will insist on LMI if you’re borrowing over 80 per cent of the property’s value, as lending you money is deemed more risky. While LMI is a one-time cost, it’s often added to your home loan, and can therefore add thousands to the amount you owe. Saving a 20 per cent deposit should eliminate the need for you to pay LMI, which is something to consider if you want to reduce your overall mortgage.

It’s also important to keep in mind that many lenders tier their interest rates based on the deposit you’ve got. So if you’ve got a higher deposit, you may be able to negotiate for a better deal.

Lenders will look at your capacity to meet monthly repayments by examining your post-tax income and your other commitments. They’ll also most likely test your capacity to make your repayments if interest rates go up by 2 or 3 per cent, which is what’s called a ‘repayment buffer’. 

When budgeting, it’s important to take this repayment buffer into account so you can approach a lender with confidence knowing that you’ll still be able to meet repayments if the market changes. This, in turn, may put you in a better position to secure the loan you want. 

A good rule of thumb is using an interest rate that’s at least 2 percentage points higher than current rates. Wayne Stewart, from the Real Estate Institute of NSW says, “when interest rates are low they can only go in one direction and that is upward, so you should always take into consideration with your due diligence and extra couple of percentage points for when interest rates do go up you can plan forward”.

To give you an idea of how interest can change your repayments, imagine you took out a $350,000 loan with a variable interest rate of 4 per cent, making monthly principal and interest repayments of $1671 over a 30-year term. If that rate rises to 6 per cent, you’ll have to pay $2098 per month; over $400 extra in monthly repayments.

Failing to budget for interest rate rises could see you falling behind in your mortgage repayments, putting financial stress on your household. 

Even if rates don’t rise, having that buffer puts you in a position to increase your repayments voluntarily and pay off your home loan sooner.

When you’re looking at your dream home, it can be tempting to get caught up in the excitement without stopping and thinking about the money you’ll owe over the next 20 or 30 years, but it’s important to crunch the numbers and understand what you can afford, before you even start your home hunt. By doing this, you’ll avoid getting your heart set on a home that’s beyond your means and you’ll be able to spend your time more effectively, looking at properties that suit your budget and your lifestyle.

Finally, it’s important not to just ‘set and forget’ your home loan. You may be able to refinance your mortgage down the track to secure a better interest rate, reduce your repayments, access different features, consolidate debt, or access home equity.