According to comparison site RateCity, around 70% of home loans now require a deposit as low as 5% of the property’s value. But there are good reasons to build a more substantial deposit.
The amount you can borrow relative to your home’s value is known as the “loan to valuation ratio” or LVR.
Traditionally, home buyers have aimed for a deposit of 20% with an LVR of 80%. However high property values are making it difficult for some buyers, especially first timers, to achieve that target. In response, LVRs are being relaxed by a wide selection of lenders.
This may open the door for more first home buyers to get into the property market. In fact a loan with an LVR of 95% could see you buy a $400,000 home with as little as $20,000 of your own money.
But having a small deposit inevitably means paying a very solid lenders mortgage insurance (LMI) premium. And that’s a significant pitfall.
Lenders will insist that you take out LMI if you are borrowing more than 80% of the property’s value. It’s a one-off cost organised by your lender. As a home buyer you don’t need to shop around for it.
The catch is that it’s designed to protect the lender, not you – the borrower, in the event that you cannot keep up the loan repayments.
If a lender faces a forced sale of your home and the sale proceeds don’t recoup the full value of the outstanding loan, LMI covers the lender for the difference.
That’s all good for lenders, but for home buyers LMI can be a major expense. Let’s say for example, that a first home buyer purchases a $400,000 property with a deposit of $40,000 – or an LVR of 90%. In this case, the LMI premium will cost a staggering $5,040. You can always add it to your loan though this means paying an extra $40 in monthly repayments.
If the same first home buyer purchases a $400,000 property with a deposit of just $20,000 – an LVR of 95%, the LMI premium is around $10,400. That’s an extra $88 each month if you tack the cost onto your home loan.
When you look at the numbers in this light, I reckon it’s reasonably clear that having a small deposit can be a case of false economy. Remember too, the smaller your deposit, the more susceptible you are to any future increases in interest rates or a reduction in your personal income.
I realise that saving for a first home isn’t easy. And it can be very tempting to go for a loan with a high LVR. But it’s an option that could leave you financially skewered.
Chances are, you’re better off focusing on building a decent deposit. This will minimise the amount of money you need to borrow, and maximise your ownership in the place from day one.