- A 5% deposit allows you to get your foot in the door sooner, build up equity while in the home, and hopefully take advantage of time in the market, rather than outside of it waiting to save.
- However you will have to keep in mind Lenders Mortgage Insurance (LMI) which can cost thousands, but the government's Home Guarantee Scheme does away with this.
- You can often pay LMI as part of the loan rather than upfront, but you will pay interest on this, and it will increase your regular repayments.
- You will also have to contend with higher repayments and more interest paid, but this could be worth it to kick your property goals sooner.
- At the pointy end of the mortgage market it's important to compare your options.
As Jerry Seinfeld once quipped about paracetamol, do I want fast-acting, or long-lasting? The apparent requisite to get your foot on the property ladder is a 20% deposit - but this takes a while to save up. So are you the early bird who gets the worm, or are you in the ‘good things come to those who wait’ camp?
Domain research indicates in the capital cities - especially in Sydney and Melbourne - it can take first home buyers more than 10 years to save up a 20% deposit for a modest home. Take a look back to 10 years ago - what were property prices doing?
A decade is a long time to save, and it’s realistic to see your ideal first home slip from your finger tips by taking that long. Theoretically, saving up just a 5% deposit cuts that time to 2.5 years. So, why doesn’t everyone do it?
While you get your foot in the door sooner, there’s additional costs to consider. Also called 95% loan-to-value ratio (LVR) home loans, here’s what to weigh up with home loans requiring only a 5% deposit.
Compare 95% LVR Home Loans
| Lender | Home Loan | Interest Rate | Comparison Rate* | Monthly Repayment | Repayment type | Rate Type | Offset | Redraw | Ongoing Fees | Upfront Fees | Max LVR | Lump Sum Repayment | Additional Repayments | Split Loan Option | Tags | Features | Link | Compare | Promoted Product | Disclosure |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
5.99% p.a. | 5.99% p.a. | $2,995 | Principal & Interest | Variable | $null | $null | 95% | |||||||||||||
6.09% p.a. | 6.11% p.a. | $3,027 | Principal & Interest | Variable | $0 | $195 | 95% | |||||||||||||
6.19% p.a. | 7.33% p.a. | $3,059 | Principal & Interest | Fixed | $248 | $350 | 95% | |||||||||||||
6.29% p.a. | 6.32% p.a. | $3,092 | Principal & Interest | Variable | $0 | $300 | 95% | |||||||||||||
6.59% p.a. | 6.86% p.a. | $3,190 | Principal & Interest | Variable | $295 | $0 | 95% | |||||||||||||
6.65% p.a. | 6.70% p.a. | $3,210 | Principal & Interest | Variable | $0 | $745 | 95% | |||||||||||||
6.74% p.a. | 7.09% p.a. | $3,240 | Principal & Interest | Variable | $0 | $0 | 95% | |||||||||||||
6.79% p.a. | 6.81% p.a. | $3,256 | Principal & Interest | Variable | $0 | $210 | 95% | |||||||||||||
6.84% p.a. | 6.92% p.a. | $3,273 | Principal & Interest | Variable | $0 | $995 | 95% | |||||||||||||
6.74% p.a. | 6.78% p.a. | $3,240 | Principal & Interest | Variable | $0 | $0 | 95% | |||||||||||||
6.89% p.a. | 6.92% p.a. | $3,290 | Principal & Interest | Variable | $0 | $300 | 95% | |||||||||||||
7.14% p.a. | 7.52% p.a. | $3,374 | Principal & Interest | Variable | $395 | $350 | 95% |
Advantages of 5% Deposit Home Loans
Foot in door sooner
Even with the fastest interest rate increase for more than 30 years taking place from May 2022, interest rates are still low, and property prices very high. Saving a deposit is still often the biggest hurdle for home buyers, not the repayment. By coming to the table with a 5% deposit, you can get a roof over your head sooner and build up equity IN the market, rather than run the treadmill on the outside.
Leverage and capital growth
A 5% deposit lets you leverage more of your money. For example, let’s say you have $30,000 saved up - a 95% LVR loan will allow you to borrow up to $570,000, for a $600,000 property value. There’s not many other reliable avenues to invest in something with this type of 19-1 leverage.
As mentioned this allows you to get your foot in the door sooner, build up some equity and hopefully realise some capital gains along the way. In a hot market, the capital gains could far outweigh the lenders mortgage insurance you’ve paid after a few years - of course, capital gains aren’t guaranteed.
Refinance after you build equity
While a bank might sting you with a higher interest rate on 95% LVR mortgages, if you have a variable home loan there’s nothing stopping you from refinancing after you’ve built up 20% equity. This might allow you to get a better mortgage rate, or a product with more flexible or appealing features, such as an offset account.
Take advantage of government schemes
A government scheme proving popular is the Home Guarantee Scheme. This scheme allows a certain number of first home buyers each financial year to enter the market with a 5% deposit without paying lenders mortgage insurance (LMI). This is a big leg up, because this often costs thousands of dollars. Places are limited, but there are lots of lenders participating and this could be one option if you want to get your foot in the door.
Disadvantages of 5% Deposit Home Loans
Lenders mortgage insurance (LMI)
The big elephant in the room, LMI is an insurance premium charged to borrowers that have less than a 20% deposit saved. A common misconception, it doesn’t protect you, but the lender in case you default on the loan (i.e. have payments more than 90 days past due).
There are two main providers of LMI in Australia - QBE and Helia (formerly Genworth) but your lender might use only one and you don’t get a choice. LMI can cost first home buyers thousands of dollars - here’s a breakdown using InfoChoice Group LMI calculators:
|
Estimated property value |
95% LVR LMI cost |
90% LVR LMI cost |
85% LVR LMI cost |
|
$200,000 |
$6,137 |
$2,574 |
$1,299 |
|
$400,000 |
$15,428 |
$6,552 |
$3,390 |
|
$600,000 |
$23,954 |
$13,284 |
$6,463 |
|
$800,000 |
$41,344 |
$14,400 |
$6,800 |
LMI could easily be as much as your deposit. However some lenders bake it into your loan, meaning you effectively borrow more and pay interest on it.
Premiums might be waived if you have a 10% deposit and are in an esteemed profession, such as medical professionals. Some banks also waive LMI If you have a 15% deposit, but the higher interest rates might not be worth it.
Larger repayments
It seems obvious but you’re borrowing 95% of the property’s value, and potentially paying off more if you’ve baked the LMI into the loan.
To give a cost breakdown, if you have borrowed $570,000 for a $600,000 home at 5.50% p.a. interest over 30 years, that’s $3,236 per month.
If you had saved up 20% you’d be borrowing $480,000, which would mean a $2,725 repayment under the same circumstances, or a saving of more than $500 a month.
You will have to factor in the higher repayments with your budget and income.
Risk of negative equity
Think of equity as your skin in the game. You are entering the market with only 5%. While property might seem like it only goes up in value, there tends to be a lot of blips and dips along the way. It’s very realistic for you to lose more than 5% of value on the property, which means owing more on the home than it’s worth - called negative equity.
This is only a paper loss until you sell, so if you have less of a deposit, it could be a wise move to purchase the property with a long term holding goal of more than a few years.
Higher interest rates and interest paid
Higher-LVR home loans likely attract higher interest rates. RBA data indicates over the past few years that the gulf has been 15 basis points for new owner occupier loans. This is when comparing over/under 80% LVR. The gulf is likely to be wider still when comparing 95% LVR loans specifically.
Aside from that, assuming interest rates are the same using the circumstances above, a $570,000 loan (95% LVR) ends up costing more than $1.16 million over 30 years, versus just over $981,000 if you had borrowed $480,000 (80% LVR) - a saving of more than $170,000.
However your interest rate likely won't remain the same for 30 years, and you might refinance in that time. You will also have to consider if $179,000 extra in interest paid (plus LMI) is worth the opportunity cost of potential capital gains over that timeframe.
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