The tough question facing first home buyers: spend more time or more money?

The tough question facing first home buyers: spend more time or more money?

Many first home buyers are having to make the tough choice between waiting additional years to save a large deposit or spend thousands of dollars extra to buy a property sooner.
 
It would take 7 years and 9 months to save a 20 per cent deposit with stamp duty for a typical Sydney apartment, if a first home buyer was stashing $400 a week into a savings account accruing 1 per cent interest, according to a RateCity analysis.
 
An apartment in Melbourne would take 5 years and 3 months under the same savings regime. For Brisbane, it’d take close to 3 years and 8 months.
 
And then there’s houses. Buying a house in the aforementioned cities would add an additional 2 to 4 years in savings time. Saving a 20 per cent deposit for a house in Sydney, for instance, would take longer than a decade.

Buying unit ratecity deposit.JPG

Buying home ratecity deposit.JPG

Time vs Money

Banks generally charge lenders mortgage insurance (LMI) to first home buyers who have a deposit less than 20 per cent. The fee -- typically costing thousands of dollars extra -- helps banks hedge the risks of a mortgage default by adding extra cash to their balance sheets. 
 
A recent government report found people could get into the property market years quicker if they could secure properties with smaller deposits and not have to pay LMI.
 
Buying a property with a smaller deposit may mean people can save on rent, but this could be offset by the cost of servicing a more expensive loan, Sally Tindall said, research director at RateCity. 
 
“For most lenders, a deposit that falls short of 20 per cent means you’ll have to fork out for LMI which can run well over $10,000,” she said.
 
“It also means your monthly repayments will be higher and you’ll pay more in interest over the life of your loan; two factors that could potentially be offset by rising property prices, but in this market, isn’t a given.”
 
Budding buyers should keep four things in mind before making a decision, Ms Tindall said.

  1. Spend within your budget
  2. Find a savings account with a competitive interest rate
  3. Compare mortgage interest rates and calculate repayments to help you work out how much you’re comfortable borrowing
  4. Find out what grants or government subsidies are available.

One way to help people figure out if paying LMI is worth buying a property sooner is to consider the affordability of servicing the loan, Kent Lardner said, a location analyst and chief executive of SuburbTrends.

“My personal view is affordability is the elephant in the room for first home buyers,” he told RateCity.

“I personally would never shy away from using LMI, as long as you can afford the repayments.

“Given current interest rates, I would focus very much on how you can service the loan.”

A government subsidy that could save four years

The federal government has made it possible for thousands of people to buy a property with mortgage deposits as small as 5 per cent while not needing them to pay loan mortgage insurance.
 
The first home loan deposit scheme makes it possible for people to secure a mortgage with a deposit as small as 5 per cent. This is because the government’s $400 million scheme guarantees the remaining shortfall; the gap between the borrower’s deposit and 20 per cent. 
 
The scheme has helped first home buyers enter the property market four years quicker on average, the first report on its progress claims. In NSW, people were able to enter the market five years quicker. 
 
About 10,000 applicants are approved each financial year for the scheme.

A forecast of falling property prices: bank

The traditionally steady property market is enduring a period of volatility due to the uncertainty brought by the COVID-19 pandemic, according to banks, analysts and industry experts. 

Banks have forecast drops in major city property prices, although some have revised their estimates as the country is generally dealing with the pandemic better than expected. 

While some investors believe a drop in property prices presents opportunity, Ms Tindall said trying to time a property purchase in the midst of a pandemic is going to be tricky. 

“If you are looking to buy your first place to call home, it’s worth taking a step back and looking at the bigger picture,” she said.
 
“Does it suit your work life? Does it suit your lifestyle? And most importantly, is it something you know you’ll be able to afford, even if things get worse financially?
 
“Bargain hunters are likely to spend the next few months trying to pick the ‘right’ time to buy, and even then, there’s a chance they won’t get it right.”

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Learn more about home loans

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.

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.

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.

How do I save for a mortgage when renting?

Saving for a deposit to secure a mortgage when renting is challenging but it can be done with time and patience. If you’re on a single income it can be even more difficult but this shouldn’t discourage you from buying your own home.

To save for a deposit, plan out a monthly budget and put it in a prominent position so it acts as a daily reminder of your ultimate goal. In your budget, set aside an amount of money each week to go into a savings account so you can start building up the ‘0’s’ in your account.  There are a range of online savings accounts that offer reasonable interest, although some will only off you high rates for the first few months so be wary of this.

If you aren’t able to save a large deposit, you can consider ways of entering the market that require small or no deposits. This can include getting a parent to act as guarantor for your home loan or entering the market with an interest only loan.

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 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

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 Lender's Mortgage Insurance (LMI)

Lender’s Mortgage Insurance (LMI) is an insurance policy, which protects your bank if you default on the loan (i.e. stop paying your loan). While the bank takes out the policy, you pay the premium. Generally you can ‘capitalise’ the premium – meaning that instead of paying it upfront in one hit, you roll it into the total amount you owe, and it becomes part of your regular mortgage repayments.

This additional cost is typically required when you have less than 20 per cent savings, or a loan with an LVR of 80 per cent or higher, and it can run into thousands of dollars. The policy is not transferrable, so if you sell and buy a new house with less than 20 per cent equity, then you’ll be required to foot the bill again, even if you borrow with the same lender.

Some lenders, such as the Commonwealth Bank, charge customers with a small deposit a Low Deposit Premium or LDP instead of LMI. The cost of the premium is included in your loan so you pay it off over time.

How much can I borrow with a guaranteed home loan?

Some lenders will allow you to borrow 100 per cent of the value of the property with a guaranteed home loan. For that to happen, the lender would have to feel confident in your ability to pay off the mortgage and in the security provided by your guarantor.

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.

How do I calculate monthly mortgage repayments?

Work out your mortgage repayments using a home loan calculator that takes into account your deposit size, property value and interest rate. This is divided by the loan term you choose (for example, there are 360 months in a 30-year mortgage) to determine the monthly repayments over this time frame.

Over the course of your loan, your monthly repayment amount will be affected by changes to your interest rate, plus any circumstances where you opt to pay interest-only for a period of time, instead of principal and interest.

What is an interest-only loan? How do I work out interest-only loan repayments?

An ‘interest-only’ loan is a loan where the borrower is only required to pay back the interest on the loan. Typically, banks will only let lenders do this for a fixed period of time – often five years – however some lenders will be happy to extend this.

Interest-only loans are popular with investors who aren’t keen on putting a lot of capital into their investment property. It is also a handy feature for people who need to reduce their mortgage repayments for a short period of time while they are travelling overseas, or taking time off to look after a new family member, for example.

While moving on to interest-only will make your monthly repayments cheaper, ultimately, you will end up paying your bank thousands of dollars extra in interest to make up for the time where you weren’t paying off the principal.

How can I get a home loan with no deposit?

Following the Global Financial Crisis, no-deposit loans, as they once used to be known, have largely been removed from the market. Now, if you wish to enter the market with no deposit, you will require a property of your own to secure a loan against or the assistance of a guarantor.