MAKING SMALL DEPOSITS WORK

Rising prices have made it tempting for buyers to use smaller deposits, but there are hidden risks, writes

The booming market has created a dilemma for homebuyers.

With prices surging on a near-weekly basis, many home seekers have had to weigh up whether it is better to buy with a smaller deposit to get into the market sooner. The alternative, and more traditional option, would be to keep saving for a 20 per cent deposit.

The danger is the sum they will need keeps changing and they could wait years to catch up. The result is paying a much higher price. Some would-be buyers may never get there.

Given this reality, it may be tempting to buy with a smaller deposit. But this, too, has risks.

Buying with less than 20 per cent will normally incur pricey lenders’ mortgage insurance. Those with smaller deposits also tend to be more exposed to fluctuations in the housing market. It might make sense when prices are rising, but were they to fall, the buyer would be in danger of having a mortgage worth more than their home.

With this in mind, we have spoken to the experts for advice on how to navigate loan options and decide what size deposit they need.

LOOKING TO THE FUTURE

Advanced Property Strategies director Nhan Nguyen has made a career out of buying houses with little or no money down. Mr Nguyen said buyers should keep in mind there was no telling what the market would do down the track, so it was unwise to assume prices would keep rising.

“You don’t want to put yourself in a position where you have to rely on price growth to make the purchase work,” he said.

“It’s easy to look at recent growth and assume you’re going to miss out unless you buy soon, but it’s impossible to know that. When you buy with a smaller deposit and bank on price rises, you are speculating.”

Mr Nguyen said buyers should try not to focus only on short-term needs and keep the bigger picture in mind.

ADDING VALUE

The best properties to buy with smaller deposits were established houses with scope to improve through a cosmetic renovation, Mr Nguyen said. The renovation meant those with a smaller deposit could add value to the property and put themselves into a better equity position. But there is a catch.

“You need money for a renovation,” he said. “If you don’t have the money, borrowing from friends or family is your best bet. There is no real other way around that.”

Mr Nguyen said another way to make it safer was to buy under the market value. This usually meant buying a property where the vendor valued a speedy sale.

ADDED COST OF LOW DEPOSIT

Those who bought with smaller deposits should not underestimate the added cost of lenders’ mortgage insurance, Canstar group executive Steve Mickenbecker said.

Economic modelling by the comparison group showed having to pay the insurance would add about $5500 to the annual cost of a loan for someone buying a $700,000 property. These costs would increase substantially for pricier homes.

“Over many years, it really starts to add up,” Mr Mickenbecker said. “No one has a crystal ball that can see what the market will do, so you have to go in knowing exactly how much buying earlier with a smaller deposit will add. A lower deposit means a bigger loan and you have to wrap the cost of LMI into that.

“You also might not qualify for a better loan rate, so you have to pay more interest.”

He said these costs needed to be considered against the history of price movements: “Prices do historically go up over the long-term, so there is a risk in being too cautious with a deposit. I can understand why you’d make the call to buy sooner with less. You just need do it with your eyes wide open. There’s a huge tradeoff.”