If you’re scouting the town for your very first home, you’ve likely encountered the misty-eyed home owner who speaks of a ‘wonderful’ time when one could borrow 100% of the capital needed for the keys to your very own kingdom. Cue sad violin about the world we live in today.
It’s true: well before the Global Financial Crisis hit, banks would lend you up to 105% of the cost of a home. We all know the moral behind that story, so I’ll save you the brief economics detour.
Here’s a secret: borrowing 100% of the cost of your home was a really bad idea back in the day. If you’re looking to buy your first home in today’s housing market, the amount you put down as a deposit can make a world of difference for your personal finances.
Why does the size of my home loan deposit matter?
To put it simply, the smallest deposit a bank will accept is 5% of the property cost. A 95% Loan to Value Ratio is entirely possible….but not particularly advisable.
When you apply to borrow more than 80% of the value of a property, you’re presenting yourself as a potentially risky candidate. A small deposit implies many things, namely a lack of financial discipline, an unsteady income, and a decreased capacity to pay back a home loan.
If you’re unable to afford a home loan deposit, what chance do you have of successfully committing to a home loan?
A story of two home loan deposits
Ben and Lisa have been renting for 7 years now. They decided about 5 years ago that they wanted to buy their own home to grow their family in, so they committed to saving for their first home. Because they can demonstrate to the bank that they’re disciplined with their money and have genuine savings, they can prove that they have the willpower, capital and steady income to pay back a mortgage on time.
On the other hand, we have Jess who’s been living at home her entire life. She desperately wants independence, so she opts to buy her own home instead of house sharing. She has the full 5% of a home loan saved – because she’s been lucky to be living at home – so she’s able to take out home loan for 95% of the mortgage.
So both parties should be pretty happy with their new homes, right?
Unfortunately for Jess, there’s more to buying a home than putting down a deposit. Even though she’s been saving consistently for more than three months – a general benchmark that banks use to assess your financial discipline – things aren’t looking great for her.
Let’s do the math and see what bodes for our mate Jess.
Low deposit = high interest rates and insurance premiums
If you choose to pay a lower home loan deposit, the banks will shore up any risk posed with a hefty Lender’s Mortgage Insurance (LMI) premium. This protects the lenders in the unfortunate event of you defaulting on your home loan. True, your house is a form of security, but if its value declines, it might not be enough to cover the costs you owe.
If you purchase a house in Sutherland for $500,000 and borrow 95%, the LMI would be approximately $16,000. Two per cent of the LMI can sometimes be put on the loan, taking it up to 97%. So, in this scenario with a 95% loan, you still need a deposit of 12%.
Similarly, your home loan deposit can impact the interest rate you pay on your home loan. The biggest your home loan deposit, the more negotiating power and choice of lenders you’ll have.
Because home loans aren’t so simple – particularly with such a small deposit – you also need to take into account all the other up-front costs that go hand-in-hand with property ownership.
The largest costs on top of purchase price is stamp duty. In NSW, a property worth $500,000 will see you paying around $18,000 in stamp duty.
You can work out your own stamp duty
There’s a whole load of paperwork involved with preparing the documents which make you the legal owner of a property. Expect to pay around $2,000 to transfer a property into your name.
Removalists, council fees, strata fees, building insurance and repairs all costs extra.
Give it to me straight – how much do I need for a home loan deposit?
Ok, ok. To put it as simply as possible, you need 24% of the home loan saved to avoid a jaw-dropping LMI premium. Twenty per cent is for the cost of the property, and the other 4% is for the other up-front costs of buying your first home.
Even going for the jaw-dropping LMI premium at 97%, you’ll need a 12% deposit. This covers the 5% towards the property, 4% costs and 3% towards LMI. (These are obviously rough rules of thumb, we can work the specifics out for you).
It’s not too complicated: the less you borrow, the less you have to pay back.
Don’t want to pay LMI? Getting a guarantor is your next best option.
Not sure where you stand? Talk to a mortgage broker!
A mortgage broker can also help you figure out the exact cost of your home – stand duty, council fees and all! You’ll also save time, energy and money, because a mortgage broker knows all the short cuts to home ownership.
Stop the guesswork today – get in touch for our honest, genuine and free advice.