Be more successful when buying property by knowing your way around home loan deposits.
Gone are the days where prospective buyers could borrow the full cost of a property plus enough to cover the extra costs that come along with it. Borrowers now need to plan their borrowing strategy and decide whether or not to spend some extra time saving up a large deposit, or pay lenders mortgage insurance and apply for a loan with a small deposit.
A quick summary
- Regular borrowers: 20% of the property purchase price
- Regular borrowers paying Lender's Mortgage Insurance (LMI): As little as 5% of the purchase price, but depends on the lender and the merits of your application
- Low doc borrower: 40% of the purchase price
- Low doc borrowers paying LMI: 20% of the purchase price
How much deposit do I need for a home?
A minimum deposit of 20% of the property's purchase price is required by most lenders for a home loan, however if you pay LMI, you'll usually need only a 5 - 10% deposit. If you're a low doc borrower, the minimum deposit will be 40%, or 20% if you take out LMI.
What percentage of the purchase price is required for a home loan deposit?
Lenders have different policies regarding the minimum deposit they require from borrowers to qualify for a home loan, but generally speaking most borrowers need only 5% of the price of the property as a deposit. Before you think of selling your car or mother’s jewellery to get your foot on the property ladder however know that a 5% deposit comes with some drawbacks, namely the sometimes misunderstood lenders mortgage insurance (LMI).
LMI is taken out by your lender if your loan to value ratio (LVR) is too high. LVR is the amount you need to borrow as a percentage of the purchase price of the property.
This can be worked out by first subtracting your deposit from the purchase price of the property. Then divide the purchase price of the property by this number.
On a $300,000 property with a deposit of $50,000.
$300,000 - $50,000 = $250,000.
$250,000 / $300,000 = 0.833
0.83 x 100 = 83%.
This means the LVR for this property purchase is 83%
As mentioned above this can vary among lenders, but is usually applicable for those buying a home with a deposit of less than 20% (an LVR of 80%) of the purchase price.
Many borrowers make the mistake of assuming LMI is an insurance which covers them because they have to fork out thousands to pay for the LMI premium. This isn’t the case. A lender sees a borrower with a deposit of less than 20% as high risk because XYX meaning LMI is taken out in the event they default on their repayments and the lender loses out when they sell the borrowers property, hence the borrower has to pay the once-off premium when they take the loan out.
Borrowers with a deposit which totals 20% or more of the loan amount are seen as lower risk and therefore don’t have to pay LMI premiums. In addition, some loans offer additional features or lower interest rates to reward these types of borrowers with higher levels of deposits saved.
The amount you have to pay for LMI is also linked to the size of a deposit. As the deposit gets smaller as a percentage of the loan amount, the LMI premium gets larger.
Case Study: Terry
Terry wants to get into the property market. He's saved a total of $60,000 to use as his deposit for a home. He's currently tossing up between buying a home in his hometown of Mount Sheridan in regional QLD which is for sale for $329,000, or buying a unit where he currently works in Glebe near Sydney CBD for $420,000.
According to the Genworth LMI estimator, Terry would have to pay a premium of $1,102 for a 30 year loan term if he purchased the Mount Sheridan home. This is based on the fact that Terry would have just over 18% of the purchase price of the property, or in finance-speak a loan-to-value ratio (LVR) of about 82%.
If he instead bought the Glebe unit Terry would present more of a risk to his lender and would therefore pay an estimated $3,600 on a 30 year loan. This is because Terry would have a smaller deposit in relation to the purchase price of the property, in this case about 14.3%, or an LVR of just over 85%.
As with much of the property market there's no black and white solution and this example doesn't take into account capital growth and other reasons why paying LMI may be beneficial in the long term.
Deposit disappointment - stamp duty and other costs
A common pitfall associated with calculating your deposit size is not taking into account the other costs associated with purchasing a home. These costs can burn a hole in your wallet, but the size of the hole WILL depend on who you are. First home buyers in some states can get away with minimal stamp duty costs while second time property buyers and investors may get slugged thousands.
In Sydney, a first home buyer purchasing a new property under $500,000 will pay no stamp duty, whereas other buyers will be up for a $19,115 bill.
According to property investment expert Chris Gray stamp duty and inspections can add significant costs to your purchase.
Very roughly speaking you should add 5% onto the purchase price of the property for stamp duty, legals and inspections
Gray also says buyers shouldn’t forget about the other costs they may pay at the time of purchase, including $250 for strata if applicable, $600 for a valuation and 2.2% of the purchase price if they choose to use a buyers agent. Failing to plan for these could mean your 20% deposit shrinks down to 15% and puts you in LMI land.
Does a deposit need to be in cash?
Deposits on property do not have to take the shape of cash. There are several acceptable sources of funds that can meet the percentage requirements like savings and chequing accounts, gift funds and rent credit. These are all acceptable sources of funds for the loan deposit, although the lender will have the final say on what’s acceptable for a home loan deposit.
Can I avoid paying LMI if I have a small deposit?
Lenders can choose to use the equity in different properties the borrower owns, or they could allow others to help bolster the loan through a guarantor loan. A guarantor loan allows a family member to use their own property as security for the borrowers loan. They could choose to provide only enough security so that the borrower’s deposit is large enough to avoid LMI, or enough to also cover the other upfront costs associated with buying a home such as stamp duty.
Comparison of a Home Loan Guarantor feature
Rates last updated January 17th, 2017.
- ING DIRECT Orange Advantage Loan - $150,000+ (LVR > 90% Owner Occupier)
Comparative rate increases by 0.15% | Interest rate increases by 0.15%
December 12th, 2016
- NAB Tailored Fixed Rate Home Loan - 2 Year Fixed (Owner Occupier)
Comparative rate increases by 0.04% | Interest rate increases by 0.23%
January 16th, 2017
- NAB Tailored Fixed Rate Home Loan - 3 Year Fixed (Owner Occupier)
Comparative rate increases by 0.05% | Interest rate increases by 0.20%
January 16th, 2017
The history of loan deposits
- In the past a traditional down payment of 20% of the total purchase price was necessitated by most lenders.
- This had to come in the form of cash and lenders usually had strict prohibitions on borrowing to get it.
- The deposit helped secure the loan if the buyer didn't pay up, acting as a form of compensation if the buyer didn't come through with his loan payments.
- Nowadays the price of homes has risen so much it's difficult for buyers to save a 20% deposit.
- In an effort to keep the property market accessible for buyers, lenders have created various terms such as guarantor loans.