For many people, putting together a deposit for a home loan is one of the biggest savings undertakings in their life. Right now, the size of your deposit is even more important than ever, with home prices still at sky-high levels and interest rates bouncing back from record lows.
For many putting together a deposit big enough for the home they want is a daunting task - so how big does it need to be? You can use our variable-rate mortgage comparison tool to filter products that cater for borrowers with less than a 20% deposit.
Why does your deposit size matter?
Loan to value ratio (LVR) is a shorthand lenders use to measure the proportion of a property sale that a home loan makes up. The bigger your deposit (or the lower your LVR), the less money you will have to borrow, and therefore less you will pay in interest. Lenders also tend to impose higher interest rates on higher LVR transactions as they represent a bigger risk.
Say for example, your home value is $500,000. An 80% LVR - or 20% deposit - would mean you'd need to save up $100,000. Conversely, a 5% deposit or 95% LVR would mean you'd need to save up just $25,000.
If your deposit is at least 20% of the total property price (or your LVR ratio is lower than 80%), you can also avoid paying Lenders mortgage insurance (LMI). This is an additional cost imposed by the bank on loans of over 80% of the property value, to protect themselves in the event of default.
LMI can easily cost thousands or tens of thousands of dollars.
Should I get a foot in the door with a smaller deposit?
Conservative logic says it makes sense to wait until you have accumulated a 20% before entering the property market to avoid paying LMI. The only problem is this could be akin to trying to run up a down escalator.
With a few notable exceptions, house prices usually increase over the years, so a house you can just about afford now may be out of your price range by the time you've saved up a 20% deposit. Domain research shows first home buyers in the big cities can take upwards of eight years to save for a 20% deposit on a modest home. What was your home's value eight years ago?
Paying for LMI in this regard might make more sense than waiting to save up for a 20% deposit and watching homes in your area increase in value by $20,000, $50,000 or more in that time. Of course, past performance is not a reliable indicator of future property price performance.
If you are ready to become a home owner, and don't want to risk house prices spiking by the time you have got your deposit together, you might decide to go ahead with deposit of less than 20%.
Pros of smaller home loan deposits
Less time taken to save for a deposit
If you decide to go ahead with a high LVR loan (say 90%), you can get your 10% deposit saved in half the time it would have taken you to get a 20% deposit together. If you have a burning desire to quickly enter the property market, going ahead with a smaller deposit is a good way to reduce the time you will spend saving. This also helps you to get ahead of the curve when it comes to property prices: the same property might be worth 30% more if you wait another two years to save up the full 20%.
Take advantage of First Home Loan Deposit Scheme (FHLDS) and other government initiatives
The FHLDS is a federal initiative designed to help first home buyers get a 95% LVR mortgage while avoiding LMI. The government acts as a guarantor for up to 15% of the property value, reducing the risk for the lender and allowing you to buy a first home with a small deposit. There are other government grants and subsidies aimed at first home buyers that are also worth exploring, that generally will be geared towards buyers with a smaller deposit.
Ability to refinance down the track
If you do decide to go ahead with a low deposit loan, that doesn't mean you are stuck with the higher rate this usually entails for the whole loan term. As you pay off more of the principal (the amount you borrowed from the bank), you build up equity in your house, essentially owning a bigger percentage of it outright. As you build equity, you have more options when it comes to refinancing, as the amount outstanding owed is reduced.
Cons of smaller home loan deposits
Lenders mortgage insurance (as you've probably realised from this article) is the main reason you might think again about going ahead with a high LVR loan. LMI can be paid upfront at the start of the mortgage, or lenders can 'bake' or capitalise it into the mortgage repayments. This however does mean you will pay interest.
As discussed, LMI capitalised into mortgage repayments makes them bigger. Lenders will often also impose higher interest rates on high LVR customers.
Risk of property price going backwards
As discussed, equity is how much of your new home you own outright. Your equity starts off simply with the amount you paid in a deposit, then slowly increases as you make more repayments. If you start off with a small deposit though, you have an increased risk of running into negative equity if property prices drop. If you have $50,000 built up in equity, but your property value has decreased by more than $50,000, you have negative equity and are paying interest on a bigger loan amount than the value of your property. This capital loss is only realised if you decide to sell your new property early on, but even so it is still something to try to avoid.
Can you get a personal loan to help with your deposit?
While it could be possible with a host of lenders, you'll have to consider that you're taking out a credit product to essentially pay for another credit product. Also consider that with personal loans - particularly unsecured ones - the interest rate is often much higher than on a home loan.
Lenders will generally prefer to see at least some of the deposit come from genuine savings. Genuine savings includes money you deposit into your savings account from your paycheque every week, fortnight or month. Cash gifts from family members may also be acceptable.
Will a guarantor help?
Lenders will consider you a less risky proposition if you nominate a guarantor. This is another homeowner who agrees to assume the burden of the loan should you be unable to make payments, typically a close friend or relative. The guarantor offers equity in their own home as security for the loan.
Using a guarantor is beneficial to those with a small deposit as lenders will often reduce or eliminate LMI with the additional security a guarantor provides. You'll need to keep in mind though that you are taking on a larger home loan, so you'll want to be absolutely sure that you can keep up with the repayments, as you defaulting on your mortgage could see your guarantor lose equity in their home.
It can also feel as if you're running up a down escalator, too. You're trying to build your deposit fund and all the while, property prices in your preferred area are rising by as much as seven per cent each year. The average house price in Brisbane at the moment is $524,000, in Sydney it's $1.2 million and the national mean is $690,200.
Ideally, you should aim for a deposit that's 20 per cent of the value of the properties you're looking at. However, if you're in Brisbane this could mean $105,000 or more and Sydney hopefuls will need $240,000 to get a foot in the door.
Sometimes, you just need to set down roots and this might mean that you get to around a 10 per cent deposit amount and decide to simply go for it. The right property comes along, you head to a mortgage calculator and realise that you can just about swing it. It can be worth the relatively high repayments in the first few years just to get on the ladder and stop paying rent.