The Pros & Cons of 5 – 20% Deposit Home Loans

You may have heard through the grapevine that banks are now opening the doors to first home buyers with below a 20% deposit. Yes this is true if your income and expenditure can meet the banks serviceability requirements.

What are the pros of securing your first home with above 80 – 95% lending or a 5 – 20% deposit?

1. Get into a property that you own, reap the rewards should you gain any equity gains through the value of the property increasing

2. No more uncertainty about your landlord selling up and having to compete to find another rental in a tough rental market.

3. Rent increases. Your landlord can legally increase your rent every 180days should he or she choose to. Have a mortgage with the ability to fix your rates from 1 – 5 years can give you that certainty you need to know exactly what you’ll be paying.

Now in saying that there are cons to securing your first home with a low deposit.

1. They are more expensive if you are an owner occupier and don’t have a 20% deposit. The majority of major banks will charge you an LEP (Low Equity Premium). There are a couple ways some banks do them.

The first is through adding a premium on top of the current market rate. This usually sit anywhere between 0.3% – 1.5% extra depending on your deposit amount. With a 5% deposit expect to be paying the highest premium vs someone with a 15% deposit. So for example if the market rate is 3.85% and you have an LEP of 1% expect your interest rate to be 4.85% as an LEP customer instead of 3.85%.

Some banks are open to adding the LEP on top of your loan to decrease your ongoing repayment amount. For example a bank might agree to charge you 1% of your entire loan amount of $500,000 which is $5000 as a fee so your loan size now becomes $505,000 without having to increase your mortgage interest rate

2. Cash incentives are not as great. Without a 20% deposit it is much harder to negotiate for not only the best interest rates but also a strong cash incentive to join the bank. On a $500,000 mortgage in today’s market I’ve seen banks providing around $3500 as a cash incentive. On the same level of debt it can be common to be offered a cash back as low as $1500 – $0 depending on your lender.

Is this forever? The answer is no if you have a plan. With a good mortgage structure recommended by a Registered Financial Adviser there are a couple ways you can get your LEP removed.

1. Set a target of the amount of debt you want to knock down to get your debt levels to 80% of the value of the property and keep to the time frame you’ve set up with that structure. For example if you bought a property for $500,000 and with a 10% deposit your loan is $450,000 you are at 90% lending. To get to 80% you’ll need to pay down an additional $50,000 to bring your mortgage down to $400,000 if the value remains the same at $500,000.

2. If you’ve managed to add value to the property through renovations or sharp buying you may be able to get to 80% just by the value of the property increasing. For example if you’ve bought the property for $500,000 with a 10% deposit of $50,000 and hold a $450,000 mortgage but after adding value it’s now with $600,000 based on a registered valuation your loan to value ratio is now 75% which means you’ve broken out of the above 80% LEP and you’re now eligible to remove your LEP of 0.3 – 1.5% and request market rates. Please keep in mind if your interest rate at the time is fixed you may incur fees and penalties so it’s best to have a plan to time it all properly.

If anyone would like me to run their situation through a bank’s debt servicing calculator (ANZ, ASB, WPAC, Co-Op or BNZ) send me a message and I’ll run a quick calculation to see if the numbers stack up against the price range of property you’re after.

Thanks for reading everyone

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