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Low Deposit Home Loans
Home loans come in many shapes and sizes. Traditionally in Australia however banks and other financial organisations have worked on the basis of a deposit of 20% of the purchase price as being your contribution to purchasing your property.
More recently purchasing patterns have changed. Higher house prices have led to fewer people being able to put down a 20% deposit with their financial institution. As a result many people are now using the service of lender mortgage insurance (LMI) or even guarantees to assist in purchasing their property.
There are many ways to achieve a low deposit home loan, ultimately it depends on how much deposit you can put down. We’ll go through a number of the popular options below.
What is a Low Deposit Home Loan?
A low deposit home loan is one where the cash contribution made to the purchase of property is less than 20% of the purchase price. As an example, a couple buying a $400,000 house would traditionally contribute $80,000 by way of deposit.
More recently other solutions have been brought forward, these include LMI, guarantees, other security, existing equity and superannuation as possible options for a low deposit home loan.
Lender’s Mortgage Insurance
Using lender’s mortgage insurance is a common strategy employed to achieve a low deposit home loan. There are many misconceptions about LMI. You need to understand how LMI works and what it covers and doesn’t cover.
What LMI Covers
Lender’s Mortgage Insurance covers the bank and not you in the case of a default. You pay for the insurance but you receive no benefit. If for example you become unemployed it does cover your repayments while you are looking for a new job. It covers the bank if, in the case of borrower default your property needs to be sold to realise the underlying security. The LMI covers the shortfall where the realised purchase price is below the value of the outstanding loan (plus fees and charges).
As is clearly demonstrated the premium (which can be capitalised to your loan) for a 95% LVR (loan to valuation ratio) is well in excess of $12,500. Once capitalised to your loan the actual cost of this insurance will be quite expensive.
LMI does have its benefits. It can get you into the house you want and gets you into your first home quickly. LMI is particular beneficial when you find a house that is undervalued and you can realise some equity in the property quickly.
Using LMI means that your credit application for finance will be heavily scrutinised. In particular, your lender will want to see evidence of a savings history for the deposit you can bring to purchase your property. If you are a first home buyer the value of any first home owner grants you may receive may also strongly assist with your application. Getting a loan will be difficult if you have a poor or average credit history. If for example you have evidence of recent defaults or possibly even late payments this will count against you.
If you have existing personal loans and/or credit cards these will also be taken into consideration when applying for credit, make sure your recent payment history is exemplary.
Guarantees are a relatively new and increasingly popular method of obtained a low deposit home loan. The recent rise in guarantees has stemmed mostly from increasing house prices and it being harder and taking a lot longer to save for the increasing levels of a 20% deposit.
How they work
A low deposit home loan with a guarantee essentially uses another person or couple to promise to pay the loan in the case that the borrowers default on the loan payments. Typically guarantors are parents wanting to see their children into their first home. Rather than having the full 20% deposit to avoid Lender’s Mortgage Insurance, parents will offer security on their residence as further collateral for the child’s first loan.
Increasingly these loans are being used by people to get into their first homes more quickly than was previously the case. Banks have become quite responsive to these types of solutions offering options such as a limited guarantee which effectively secures the 20% deposit required to avoid Lender’s Mortgage Insurance. It will depend on your bank as to whether they offer limited guarantees or unlimited guarantees. In many cases once the 80% threshold has been reached through regular repayments the banks will remove the guarantee on application from the borrower.
From the Bank’s perspective these loans are very low risk as you not only have the mortgage of the home of the borrower, but you also have the home of the guarantor being placed as security for the loans.
Having saved some of the deposit will go and long way with your lender to demonstrate you can service a loan. A savings history is essential. Banks are reluctant to lend substantial sums of money to a borrower with a limited history of savings or at the very least a demonstrated ability to repay a debt.
Guaranteed loans also have to have a very clean credit history. If you have a poor credit history think carefully about embarking on this route until you can demonstrate a better credit history.
There are many examples of guaranteed home loans ending in tears for all parties. Parents in many cases willingly signup to assist their children in good faith, but lacking an understanding of what a guarantee actually means. Case law is littered with examples of parents losing their houses where they have been forced to stand in and actually guarantee a loan.
Where you have a good savings history and strong desire to own your own home there is no reason why this would not work as low deposit home loan option.
Other Security/Existing Equity
Having existing security or exiting equity in another property may provide another option to obtaining a low deposit home loan. Options other than property also exist with possibility that shares and even a term deposit could be used as security.
The simplest option is you owning another property. If you own this other property with no finance over it then you can use this security to obtain a low deposit home loan. This is a very common strategy for property investors. Even if you have another property and you already have finance over there may be some wiggle room with regards equity. If so a partial security may enable you to obtain a low deposit home loan on another property.
This strategy is most used by people looking to buy an investment property. Buyers may have substantial equity in the current home this existing equity can assist in a subsequent property purchase.
Often financial organisations allow you to use shares or a term deposit as security to purchase property with a low deposit home loan.