First home buyers could lose out due to higher interest under government scheme

First home buyers could lose out due to higher interest under government scheme

What first home buyers could save by purchasing a new property under the First Home Loan Deposit Scheme (FHLDS) won’t be enough to offset the extra interest costs they could be facing over the life of the loan, new RateCity analysis showed.

Some Sydneysiders may be almost $800 worse off a month in mortgage repayments under the scheme, according to the calculations. 

Sydney first home buyers with 5 per cent deposits could avoid forking out nearly $40,000 in lenders mortgage insurance (LMI) if they buy a home worth $950,000, the scheme’s price cap for the Harbour City.

  • LMI is a cost that’s typically required by lenders if buyers purchase a home with a deposit smaller than 20 per cent of the property value.

First home buyers are also potentially able to enter the Sydney property market with a $47,500 deposit for a $950,000 home – significantly less than the $190,000 needed for a 20 per cent deposit.

However, if a first home buyer purchases a Sydney property with a 5 per cent deposit, the additional interest payments could snowball to more than $140,000 over a 30-year loan term. This equates to $790 extra in repayments per month.

For Melburnians, the extra interest could set them back nearly $127,000 over the life of the loan, or $707 a month, but the LMI they could potentially be saving is about a quarter of that, at some $34,000.

Brisbane first home buyers could face about an extra $97,000 over the 30-year mortgage, compared with the almost $26,000 they’d likely avoid paying in LMI.

The extra interest payments are likely to jump if the cash rate is hiked over the next 30 years.

The calculations are based on CBA’s interest rates of:

  • 3.13 per cent for those with less than 20 per cent deposit; and
  • 2.69 per cent for buyers with a 20 per cent deposit or more.

The analysis accounts for the scheme’s updated property price thresholds but does not factor in the amount of rent payments saved from moving into the purchased home.

Buying with a 5% deposit under the FHLDS vs a 20% deposit

  Deposit size Monthly repayments Interest over 30 years
Property Value 5% deposit 20% deposit Difference 5% deposit 20% deposit Difference 5% deposit 20% deposit Difference
$950,000

$47,500

$190,000

-$142,500

$3,869

$3,079

$790

$490,176

$348,272

$141,904

$850,000

$42,500

$170,000

-$127,500

$3,461

$2,754

$707

$438,578

$311,612

$126,967

$650,000

$32,500

$130,000

-$97,500

$2,647

$2,106

$541

$335,383

$238,291

$97,092

$600,000

$30,000

$120,000

-$90,000

$2,443

$1,944

$499

$309,585

$219,961

$89,624

$550,000

$27,500

$110,000

-$82,500

$2,240

$1,782

$457

$283,786

$201,631

$82,155

$500,000

$25,000

$100,000

-$75,000

$2,036

$1,620

$416

$257,987

$183,301

$74,686

$400,000

$20,000

$80,000

-$60,000

$1,629

$1,296

$333

$206,390

$146,641

$59,749

Source: RateCity.com.au. Notes: Based on CBA’s basic home loan for owner occupiers paying principal and interest with a rate of 3.13% for a loan-to-value ratio (LVR) of more than 80% and a rate of 2.69% for an LVR of 80% or less. Calculations are based over 30 years and do not include fees or stamp duty. Assumes LMI is $0.

LMI costs with a 5% deposit on FHLDS new build thresholds

Location Property Value 5% deposit Loan size LMI cost
Sydney + NSW regional centre $950K $47,500 $902,500 $37,928
Melbourne + VIC regional centre $850K $42,500 $807,500 $33,935
Brisbane + QLD regional centre $650K $32,500 $617,500 $25,950
ACT + NSW other $600K $30,000 $570,000 $23,954
Perth + Adelaide + VIC other + Hobart + NT $550K $27,500 $522,500 $21,958
QLD other $500K $25,000 $475,000 $14,872
SA other + WA other + TAS other $400K $20,000 $380,000 $11,897

Source: RateCity.com.au. Note: LMI costs taken from Genworth calculator

Risks and benefits of buying a property under the First Home Loan Deposit Scheme

Sally Tindall, RateCity’s research director, said buying a property with a 5 per cent deposit can be risky.

“If property prices fall, you could quickly find you owe more to the bank than your house is worth,” she said.

“Not only would that put you in a precarious position if you had to sell, but also it would make it near impossible to refinance until you have a decent amount of equity.”

Similar to first home buyers, refinancing mortgage holders who own less than 20 per cent of their property are generally required to pay LMI.

“The big unknown is whether property prices will rise or fall from when you buy your home. History would suggest property prices, particularly in city centres, are likely to rise over the long term, however in the short term, it’s anyone’s guess what will happen to property prices as the COVID pandemic plays out,” Ms Tindall said.

She added that banks could also charge a higher interest rate to borrowers with small deposits.

“For example, CBA is offering their basic home loan to people with a 20 per cent deposit for just 2.69 per cent. However, anyone with a smaller deposit for the same loan are charged 3.13 per cent. That’s almost half a percent more, at least until you own 20 per cent of your property.”

This is on top of the higher monthly repayments first home buyers would be facing if they purchased under the scheme, compared with someone who bought with a bigger deposit.

Ms Tindall noted that there are also benefits to using the FHLDS, including not having to pay rent while saving up for a larger deposit.

“Jumping into the housing market using this government scheme will get you into your home sooner without having to pay LMI or rent,” she said.

Potential pros:

  • Avoid lenders mortgage insurance.
  • Get into your home sooner.
  • Stop paying rent.
  • Prices could rise after you purchase your property.

Potential cons:

  • Higher monthly repayments.
  • Pay extra interest over the life of the loan.
  • Some lenders charge higher interest rates for people with small deposits.
  • Property prices could drop, potentially leaving you in negative equity.
  • Borrowing more can create more risk – potential rate rises cost you more than if you had a smaller loan, and you’re more susceptible to drops in your income.

Tips for first home buyers thinking of applying for the FHLDS

  • Read the terms and conditions of the scheme carefully, understand how much extra you’ll pay with a smaller deposit and weigh it up against any savings you might make from not paying rent.
  • Don’t bite off more than you can chew because it could end up plaguing you and your finances for years.

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Learn more about home loans

What is a low-deposit home loan?

A low-deposit home loan is a mortgage where you need to borrow more than 80 per cent of the purchase price – in other words, your deposit is less than 20 per cent of the purchase price.

For example, if you want to buy a $500,000 property, you’ll need a low-deposit home loan if your deposit is less than $100,000 and therefore you need to borrow more than $400,000.

As a general rule, you’ll need to pay LMI (lender’s mortgage insurance) if you take out a low-deposit home loan. You can use this LMI calculator to estimate your LMI payment.

What are the pros and cons of no-deposit home loans?

It’s no longer possible to get a no-deposit home loan in Australia. In some circumstances, you might be able to take out a mortgage with a 5 per cent deposit – but before you do so, it’s important to weigh up the pros and cons.

The big advantage of borrowing 95 per cent (also known as a 95 per cent home loan) is that you get to buy your property sooner. That may be particularly important if you plan to purchase in a rising market, where prices are increasing faster than you can accumulate savings.

But 95 per cent home loans also have disadvantages. First, the 95 per cent home loan market is relatively small, so you’ll have fewer options to choose from. Second, you’ll probably have to pay LMI (lender’s mortgage insurance). Third, you’ll probably be charged a higher interest rate. Fourth, the more you borrow, the more you’ll ultimately have to pay in interest. Fifth, if your property declines in value, your mortgage might end up being worth more than your home.

How much deposit will I need to buy a house?

A deposit of 20 per cent or more is ideal as it’s typically the amount a lender sees as ‘safe’. Being a safe borrower is a good position to be in as you’ll have a range of lenders to pick from, with some likely to offer up a lower interest rate as a reward. Additionally, a deposit of over 20 per cent usually eliminates the need for lender’s mortgage insurance (LMI) which can add thousands to the cost of buying your home.

While you can get a loan with as little as 5 per cent deposit, it’s definitely not the most advisable way to enter the home loan market. Banks view people with low deposits as ‘high risk’ and often charge higher interest rates as a precaution. The smaller your deposit, the more you’ll also have to pay in LMI as it works on a sliding scale dependent on your deposit size.

Will I have to pay lenders' mortgage insurance twice if I refinance?

If your deposit was less than 20 per cent of your property’s value when you took out your original loan, you may have paid lenders’ mortgage insurance (LMI) to cover the lender against the risk that you may default on your repayments. 

If you refinance to a new home loan, but still don’t have enough deposit and/or equity to provide 20 per cent security, you’ll need to pay for the lender’s LMI a second time. This could potentially add thousands or tens of thousands of dollars in upfront costs to your mortgage, so it’s important to consider whether the financial benefits of refinancing may be worth these costs.

Does Australia have no-deposit home loans?

Australia no longer has no-deposit home loans – or 100 per cent home loans as they’re also known – because they’re regarded as too risky.

However, some lenders allow some borrowers to take out mortgages with a 5 per cent deposit.

Another option is to source a deposit from elsewhere – either by using a parental guarantee or by drawing out equity from another property.

How much are repayments on a $250K mortgage?

The exact repayment amount for a $250,000 mortgage will be determined by several factors including your deposit size, interest rate and the type of loan. It is best to use a mortgage calculator to determine your actual repayment size.

For example, the monthly repayments on a $250,000 loan with a 5 per cent interest rate over 30 years will be $1342. For a loan of $300,000 on the same rate and loan term, the monthly repayments will be $1610 and for a $500,000 loan, the monthly repayments will be $2684.

What is a loan-to-value ratio (LVR)?

A loan-to-value ratio (otherwise known as a Loan to Valuation Ratio or LVR), is a calculation lenders make to work out the value of your loan versus the value of your property, expressed as a percentage.   Lenders use this calculation to help assess your suitability for a home loan, and whether you need to pay lender’s mortgage insurance (LMI). As a general rule, most banks will require you to pay LMI if your loan-to-value ratio is 80 per cent or more.   LVR is worked out by dividing the loan amount by the value of the property. If you are looking for a quick ball-park estimate of LVR, the size of your deposit is a good indicator as it is directly proportionate to your LVR. For instance, a loan with an LVR of 80 per cent requires a deposit of 20 per cent, while a 90 per cent LVR requires 10 per cent down payment. 

LOAN AMOUNT / PROPERTY VALUE = LVR%

While this all sounds simple enough, it is worth doing a more accurate calculation of LVR before you commit to buying a place as there are some traps to be aware of. Firstly, the ‘loan amount’ is the price you paid for the property plus additional costs such as stamp duty and legal fees, minus your deposit amount. Secondly, the ‘property value’ is determined by your lender’s valuation of the property, not the price you paid for it, and sometimes these can differ so where possible, try and get your bank to evaluate the property before you put in an offer.

What is an ongoing fee?

Ongoing fees are any regular payments charged by your lender in addition to the interest they apply including annual fees, monthly account keeping fees and offset fees. The average annual fee is close to $200 however there are almost 2,000 home loan products that don’t charge an annual fee at all. There’s plenty of extra costs when you’re buying a home, such as conveyancing, stamp duty, moving costs, so the more fees you can avoid on your home loan, the better. While $200 might not seem like much in the grand scheme of things, it adds up to $6,000 over the life of a 30 year loan – money which would be much better off either reinvested into your home loan or in your back pocket for the next rainy day.

Example: Anna is tossing up between two different mortgage products. Both have the same variable interest rate, but one has a monthly account keeping fee of $20. By picking the loan with no fees, and investing an extra $20 a month into her loan, Josie will end up shaving 6 months off her 30 year loan and saving over $9,000* in interest repayments.

What is a line of credit?

A line of credit, also known as a home equity loan, is a type of mortgage that allows you to borrow money using the equity in your property.

Equity is the value of your property, less any outstanding debt against it. For example, if you have a $500,000 property and a $300,000 mortgage against the property, then you have $200,000 equity. This is the portion of the property that you actually own.

This type of loan is a flexible mortgage that allows you to draw on funds when you need them, similar to a credit card.

How can I avoid mortgage insurance?

Lenders mortgage insurance (LMI) can be avoided by having a substantial deposit saved up before you apply for a loan, usually around 20 per cent or more (or a LVR of 80 per cent or less). This amount needs to be considered genuine savings by your lender so it has to have been in your account for three months rather than a lump sum that has just been deposited.

Some lenders may even require a six months saving history so the best way to ensure you don’t end up paying LMI is to plan ahead for your home loan and save regularly.

Tip: You can use RateCity mortgage repayment calculator to calculate your LMI based on your borrowing profile

How do I take out a low-deposit home loan?

If you want to take out a low-deposit home loan, it might be a good idea to consult a mortgage broker who can give you professional financial advice and organise the mortgage for you.

Another way to take out a low-deposit home loan is to do your own research with a comparison website like RateCity. Once you’ve identified your preferred mortgage, you can apply through RateCity or go direct to the lender.

Does Australia have no cost refinancing?

No Cost Refinancing is an option available in the US where the lender or broker covers your switching costs, such as appraisal fees and settlement costs. Unfortunately, no cost refinancing isn’t available in Australia.

Can I change jobs while I am applying for a home loan?

Whether you’re a new borrower or you’re refinancing your home loan, many lenders require you to be in a permanent job with the same employer for at least 6 months before applying for a home loan. Different lenders have different requirements. 

If your work situation changes for any reason while you’re applying for a mortgage, this could reduce your chances of successfully completing the process. Contacting the lender as soon as you know your employment situation is changing may allow you to work something out. 

Can I get a home loan if I am on an employment contract?

Some lenders will allow you to apply for a mortgage if you are a contractor or freelancer. However, many lenders prefer you to be in a permanent, ongoing role, because a more stable income means you’re more likely to keep up with your repayments.

If you’re a contractor, freelancer, or are otherwise self-employed, it may still be possible to apply for a low-doc home loan, as these mortgages require less specific proof of income.