It’s true that a 10% deposit is enough, in most cases, to make your move on a property. But with a deposit of 10% there are a few factors you should consider. Lending money has always been a bit dangerous to those lending it. There’s always a chance that borrowers can’t meet their repayments and so lenders look to protect themselves where they can.
Post-GFC, the setback of economic and employment conditions has caused the Australian Prudential Regulation Authority (APRA) and the Reserve Bank of Australia (RBA) to issue warnings to lenders to take more caution when assessing potential borrowers. Interest rates are now at an all time low, giving the average borrower or first home buyer the impression that repayments are affordable; but buyers need to be aware of long-term changes such as rate increases and make informed decisions so they are are financially prepared. Combined with RBA reports that household financial stress is currently under trend, more and more young Aussies may be biting off more than they can chew, however, recent data from realestate.com.au suggest the national mood is positive amongst Gen Y first home buyers
LVR – loan to value ratio
Home loans with over 80-90% loan to value ratio (LVR) are considered quite dangerous. LVR is the proportion of money you borrow (loan) compared to the value of the property (value). The leftover money is your deposit. The danger with a 90% home loan for a lender is that your monthly repayments and loan terms are higher than they would be if you had a 20% deposit, or more. For this reason LMI is charged.
LMI – Lenders mortgage insurance
LMI is a fee charged by lenders when you have a deposit less than 20% of your property’s purchase price.
On a property of $500,000, LMI is approximately $7,920 (if you’re paying a 10% deposit). As the purchaser, you need to make sure you’re happy to pay it.
The LMI is added directly to your home loan in most cases, so it’s not a fee you need to pay upfront. It acts as a security to the lender, who considers you ‘high risk’ with anything under 20% deposit. LMI protects the mortgage lender in the event that you, the borrower, default on their loan.
High loan terms (borrowing 90% of your property’s value) most likely means you’ll pay more money in interest over the course of your mortgage, as your loan will take longer to pay off. It’s worth remembering and bearing in mind.
If you fall into this category, make sure you’ve crunched the numbers and have an emergency buffer saved up in case of a rate increase.
Here are a few things you need to keep in mind if you have a higher LVR:
Guarantor home loans
- A family member, usually your parents, agree to use their property as a security for your loan
- Your guarantor will also be held liable if you default on the loan.
- If you’re prepared to mix finances and family, make sure you are aware of how you and your guarantor’s financial position can be affected.
Low deposit home loans
- Most lenders – even the big banks – only require a 5% deposit. But these types of home loans will have bigger repayments because you’re borrowing more.
- You will also incur LMI and you will be adding more stamp duty costs.
- A good idea is to also have extra funds to act as an emergency buffer in case interest rates rise again.
- As a rule of thumb, always prepare for interest rate rises of 2-3%
Long term mortgages
- Typically, a long-term mortgage is considered to be more than 30 years.
- May seem appealing because you have lower repayments
- Reality is you end up paying more because of the length of the mortgage
- Eg. If you borrowed $400,000 on a 40-year mortgage, you would pay $193,000 extra in interest than you would with the same loan but on a 30-year term (based on a 6% rate).
Whenever you’re borrowing money to purchase or refinance a home, it’s always a good idea to proceed with caution and consider the danger you pose to yourself and your family. Always compare home loans and understand all the pros and cons of the type of mortgage you choose.
Article by Jeremy Cabral, publisher for finder.com.au