Paul's Insights: How first home buyers can beat the deposit barrier
The biggest hurdle to buying a first home is often saving a deposit. But you may not need a 20% deposit, and it can be worth checking out every option at a time when property values are more affordable and we're seeing home loan interest rates below 3.0%.
Plenty of banks will let you borrow up to 90% – even 95%, of a property’s value. These ‘loan to value ratios’ (LVRs) show the maximum a bank will lend as a percentage of your home’s market value. So it can be possible to buy with a 5% deposit. However, there’s a reason why 20% is seen as the ideal down payment.
When you borrow more than 80% of your home’s value, you’ll be slugged with lenders mortgage insurance (LMI).
This type of cover protects the lender, not the home owner, and it can be a major upfront expense. Yet a report by LMI provider – Genworth, found around six out of ten millennials don’t know about LMI.
If you buy a $500,000 home with a 10% deposit (an LVR of 90%), the LMI premium will come to about $8,640. On a deposit of 5% (LVR of 95%), LMI blows out to almost $16,000.
You may be able to add LMI onto the loan. This will increase the monthly repayments but if you’re buying with a small deposit the real issue is that it can tip your loan over the bank’s maximum LVR.
There are a few ways around this conundrum.
Three out of four first home buyers plan to rely on the Federal government’s new ‘First Home Loan Deposit Scheme’ (FHLDS). It kicks off on 1 January 2020, and lets buyers get into the market with a 5% deposit. The government will guarantee the remaining 15% so there’s no need to pay LMI.
The downside is that the FHLDS will only be available to 10,000 first home buyers annually. Inevitably, some will miss out. Rather than pinning all your hopes on the scheme, it pays to have a Plan B.
One option is to have a family member act as a guarantor. Lenders are getting creative here, with family pledge loans that allow parents to nominate the percentage of their child’s loan they’re prepared to guarantee.
If, for instance, a first home buyer can save a 10% deposit, and parents agree to guarantee another 10%, this can be provide the 20% security needed to bypass LMI, while also reducing risks for the guarantor.
LMI providers are becoming more flexible too. Genworth recently announced the option to pay LMI by the month rather than upfront. If your budget can handle this, it can be a way to avoid overshooting the bank’s maximum LVR, while putting more of your loan to work funding your first home.
Paul Clitheroe is Chairman of InvestSMART, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.