When buying your home, the number 20% is constantly bandied around, but is it the be all and end all? In this article we explore this ‘magic number’ and alternatives that you can explore so that you can purchase your home with a smaller deposit.
So, why all this 20% talk?
The reason this number comes about is because banks treat loans as less risky when the amount is 80% or less of the property value. This is called an 80% LVR (Loan Value Ratio) and it’s at this level the banks are comfortable enough to not insure their risk, which is why you don’t then pay Lenders Mortgage Insurance (LMI). So basically, for a $500,000 purchase, you will need at least $100,000.
Do remember, if you’re not eligible for First Home Buyer benefits such as Stamp Duty discounts, you will need a decent sum more than the 20% for the extra costs.
What if I don’t have 20%?
If you don’t have enough to get your loan to this 80% Loan Value Ratio (LVR), you may have the option of borrowing more and then paying Lenders Mortgage Insurance (LMI). This is like any other insurance in that there is a cost for it, and whilst this insurance protects the lenders increased risk, the cost is relayed on to you to pay.
In this case, the lender can let you take up a loan with as little as 5% of the property value if you’re purchasing it to live in it or 10% if you’re an investor. That way, for the same $500,000 property, you could need as little as a $25,000 deposit if you’re buying your own home or $50,000 if you’re an investor.
Do know that if you do this the LMI cost will be passed on to you. Typically, this would be added to the loan amount, which is called capitalising the LMI. That means your home loan will also be more expensive to accommodate for this cost, as you’ll be paying interest on the total amount for the life of the loan.
” An option that many clients of ours are
exploring these days is the chance to use
a family pledge or limited guarantee. “
What if I can get a family pledge or limited guarantee?
An option that many clients of ours are exploring these days is the chance to use a family pledge or limited guarantee. In these times where you might have the income but it’s difficult to save 20% of the purchase price, this option allows certain types of people (typically close family members) to let you lean against the equity in their property and provide additional security for your loan. This gives the bank extra security so that your loan amount gets down to a total LVR of 80% when taking your purchase and this equity into consideration.
This is not the old style of guarantee saying your parents can afford the loan if you don’t, as the liability is still your sole responsibility. Further, it requires the guarantors to provide enough that secures to a specific threshold. For instance, if you have a 10% deposit, your lender may allow you to use a family guarantee to get to 20% security so that the equity in the guarantor’s home provides the remaining 10%.
This is only to be used a stepping stone to avoid LMI. Once you have paid down the loan and/or the property has increased in value to the point that the remaining loan is at an 80% LVR of the updated value, we release the family guarantee and thank the family member for helping you out!
Note that it is recommended (and often required) for the family member to get independent financial and legal advice. This is because whilst the loan is your liability to service, if you default and the worst case is realised the lender still have a call for a portion of the loan.
But wait, besides 20% what are the other up front costs?
As we touched on earlier, there can be a decent sum more required than just the 20%. When you purchase a property, there are other upfront costs such as stamp duty, legal fee, council rates and more that can really add up.
Of these costs we often focus mostly on stamp duty as this is typically the largest cost. Do note it changes state by state and you can be eligible for discounts if you’re a first home buyer.
We will always provide a rundown of overall purchasing costs that includes these (and a buffer) so that we know what you’re up for. It is important to be aware of this as you may think with your 20% you’re in the clear but find out that a substantial portion of that money you’ve worked so hard to save, is going to these costs and now you’re at an LVR over 80%.
So, should I wait until I can save more? or buy now?
It’s case by case, and really does depend on our personal situation. You might be worried about missing out on a property in your area and know that if you’re renting while trying to save you in fact could end up further behind by waiting, so in this case maybe it is worth paying the LMI instead. As silly as it may first sound, in this case saving for a larger deposit could end up costing you even more. Therefore, it’s so important to sit down and discuss your wants, needs and options with your broker.
Not sure what your next move is? Let us help you. Our consultations are won’t cost you a dime.
The information contained in this article is intended to be of a general nature only. It has been prepared without considering any person’s objectives, financial situation or needs. Before acting on this information, Credo recommends that you consider whether it is appropriate for your circumstances. Credo recommends that you seek independent legal, financial, and taxation advice before acting on any information in this article.