$15,000 boost for first home buyers
Would-be first home buyers need not despair if they are struggling to raise a 20% deposit
The first home loan deposit scheme is an exciting boost for first home buyers, allowing them to buy a property with a 5% deposit and without lenders mortgage insurance (LMI). Instead of LMI, the federal government will guarantee 15% of the home loan. In other words, the government is taking on the lender’s risk that you don’t pay off the loan.
According to Deslie Taylor, mortgage broker and principal at Mortgage Choice Ormeau, the scheme is saving first home buyers up to $15,000 off their upfront costs. It means these same buyers don’t have to immediately come up with thousands of dollars for LMI after already saving for a deposit.
Let’s say you had a 5% deposit on a $475,000 home, totalling $23,750. Add the cost to buy (solicitor fees, building and pest inspection costs and other charges) and you could easily spend another $5000. Then if you paid your LMI as a lump sum of $15,000, you would be looking at $43,750 upfront and almost double your original deposit.
Arguably if you can afford that final figure (with some wriggle room) you could form a stronger deposit on the same or another home and lessen the LMI; and similarly if you bargain down the price of your property it can reduce the LMI. But it’s not really the point of the government’s offer, and Taylor says that in the $475,000 example – if you qualified for the scheme – you’d only have to come up with $28,750 upfront for the deposit and buying costs.
You can learn more about how the first home loan deposit scheme (FHLDS) works and how to apply at the National Housing Finance and Investment Corporation (NHFIC) website.
Don’t qualify? Don’t fear
If you’re not lucky enough to qualify for the FHLDS or you’re not going to be one of the successful applicants (only 10,000 positions were on offer from July 1), don’t
fear – all is not lost. There are several other home buying grants you can apply for and they differ from state to state (see July issue, page 69).
James Symond, chief executive at Aussie home loans, says if your deposit is less than 20% of the home’s value, some lenders will allow you to add LMI to the loan, otherwise known as capitalising LMI. Here you gradually pay the insurance cost along with the rest of the loan.
The downside, says Symond, is that this will add to the long-term cost of LMI because you’re paying interest on the premium. But this can be minimised by making extra repayments.
Taylor says that in the current environment there are few lenders who will apply LMI to the loan, meaning you’ll have to pay a lump sum upfront.
“You can still buy with the lower deposit; but you’ll be looking at an interest rate that will be around 4% if not more,” she says (see table).
Symond says another option is to ask a family member to act as guarantor for your first home loan.
“Some lenders offer family pledge loans based on a guarantee from a family member, usually mum or dad,” says Symond. “This means parents offer part of their home equity as additional security for their adult child’s loan.”
This way no cash changes hands, and if you’re lucky to have the backing of the FHLDS or other grants, the extra security can push the loan security up past 20% so that LMI is no longer required. Lenders may still want to see a history of personal savings, says Symond.
If you’re unsure about your options, speak with a mortgage broker, financial adviser or your bank.
Size matters
Often you’ll only ever hear two figures when it comes to home deposits: 20% (to avoid LMI) and 5% (the
minimum deposit). But what if your deposit falls somewhere in between?
Taylor says it’s important to remember that LMI is a risk insurance. The higher the risk to the lender, the higher your premium.
“If you’ve got a 5% deposit, that’s the highest risk possible because of the equity position that the bank has retained and is holding,” she says.
“The higher the deposit, the lower the premium on LMI. If you put in a 10% deposit, the premium almost halves because that risk factor has dropped dramatically. And, of course, with a 15% deposit the premium drops again [but not as significantly].”
As a guide, says Symond, buying a $500,000 home with a 5% deposit ($25,000) can mean paying an LMI premium of almost $15,000. If you can bring the deposit up to 10% ($50,000), the cost of LMI can fall to $8680.
“Not all lenders accept 5%. However, some may accept a 10% deposit. Going that extra distance to save a bigger deposit can considerably open up the range of available lenders and help you secure a better rate,” he says.
Taylor says she sees some clients who have saved a 15% deposit. However, if they only pay 10% the difference might be $1000 in LMI. In this scenario, the client might like to retain some of their deposit for emergencies as opposed to exhausting all their savings for the sake of a $1000 saving in an LMI premium.
Lenders are offering new products too. As of July 13, St.George is charging $1 for LMI, provided you’ve saved a 15% deposit for your new home (up to a loan value of $850,000).
Capital gains
There’s a view put forward by some property experts that LMI can be offset by your home’s capital appreciation. While this is certainly possible, a lot of factors must be in your favour.
Symond says no one can predict exactly how the property market will move over the short term, so it is always risky for home buyers to assume big gains over a short period. Over the longer term, though, the picture is different as history shows that housing typically rises in value over time.
He adds that one of the best features of current home loans is that you don’t have to wait for the market to rise to build up equity in your home.
“Homeowners can take control by paying a bit extra off their home loan each month. This pays down the loan sooner, helping to grow equity in the property,” he says.
In the book Rules of the Lending Game by Melbourne-based Stuart Wemyss, a case study is provided where LMI can prove beneficial for property investors. He presents the idea that by borrowing more and paying for LMI on your first investment property, it allows you to invest more money sooner, which also allows you to benefit from compounding capital growth. Then there’s the idea that because you’ve now got a higher budget, you can buy a better quality investment.
In the book Smashed Avocado, journalist turned author Nicole Haddow presents another case study where LMI could be used to your advantage.
Let’s say you buy a $500,000 home with a $70,000 (14%) deposit. Your LMI cost could be as little as $5000, depending on your provider, says Haddow. This means a $430,000 mortgage becomes a $435,000 mortgage.
“And in the event your property value rises $100,000, the cost of your LMI is effectively absorbed by the rise in value,” she says.
“If you’d waited to save a $100,000 deposit, the property might be worth $550,000 and that means you’ll still only have [a deposit of] 18%. Had you bought it at $500,000 using LMI, you’d be ahead financially.”
Taylor says if you’re going to buy a property and put down a 10% deposit, and you’re going to be in a position to use the retained funds to improve the value of that home immediately, then there’s a discussion that’s worth having.
“For the sake of $5000 in LMI or a percentage of your LMI, let’s say you’re going to improve the value of your home by $50,000, then we have that conversation about whether it’s going to be to your benefit,” she says. She warns, however, that it’s common to see people putting all their savings into their home and then being forced to scrimp and scrape to get it renovated – even as far as purchasing a personal loan, which is only placing yourself in more debt. “If you find they’re just going to retain the [saved deposit] funds for lifestyle, then I would think you’re better off putting that money into the loan, and possibly paying the 20% deposit because chances are you’re going to waste that money and it’s going to slowly dwindle as opposed to investing that money back into the home,” she says. “Don’t have that temptation there to spend.”