Buying with a 5% deposit: the pros and cons of a smaller deposit

If you’re trying to save up for a home in Australia then you know it’s no easy feat, particularly when a 20% deposit often means squirrelling away a six-figure sum. But is a 20% deposit still necessary nowadays, and could a smaller deposit better suit some homebuyers?

A deposit is arguably the biggest upfront cost associated with purchasing a home. With rising cost of living pressures making saving a deposit even harder for everyday Australians, first home buyers hoping to achieve the Great Australian Dream of owning property should consider every option to help them get there.

By instead opting for a 5% deposit and reducing the amount of money needed to save, you could cut the time taken to save for a home significantly. However, just as there are advantages, there are risks associated with buying a home with a low deposit that are worth exploring.

 

The benefits of a smaller deposit

A home loan lender is not necessarily going to reject your application just because you have a smaller deposit. In fact, there are serious benefits for home buyers to consider by opting for a small deposit home loan.

Get on the property ladder faster – Last year, fear-of-missing-out had borrowers increasing demand and pushing up property prices by around $1,200 a day in just three months. What this means is that the longer a first-time buyer spent saving up a deposit, the more money they had to save, and the more time they spent saving – forcing them into an endless cycle. One of the best benefits of a smaller home deposit is that you will spend less time saving than if you needed a 20% deposit, helping you get into the property market faster.

Reduce your upfront costs – Buying a property is arguably the biggest purchase you’ll ever make, and the costs don’t end at the deposit. You’ll also need to factor in the potential cost of stamp duty, home loan fees, like application fees, home and contents insurance, conveyancing fees, inspection fees and much more.

By choosing to save a smaller deposit, you’ll be reducing your upfront costs. Just keep in mind that if you save a deposit under 20%, you will need to pay Lender’s Mortgage Insurance (LMI).

Utilise government assistance schemes – One of the reasons buying a home with a 5% deposit is so popular nowadays is because of the government home buyer schemes that allow you to do just that – and avoid paying LMI. Eligible Australians may be able to take advantage of federal government home buyer schemes offered through the NHFIC that allow first home buyers to get a property with only 5% saved, and single parents to get a property with only 2% saved.

 

 

What are the downsides of a smaller deposit?

It’s worth understanding exactly why home buyers are encouraged to save a larger deposit to begin with before you try to buy a home with a 5% deposit. It’s not just for the bank’s benefit, but it can seriously assist first home buyers in a multitude of ways.

You won’t pay Lender’s Mortgage Insurance (LMI) – When you purchase a home with a deposit of 20% or more, you avoid paying LMI. This is an insurance paid to the lender that protects them from the higher likelihood you may default on the loan. Having a smaller deposit positions you as a riskier borrower to the lender, and this 20% deposit benchmark showcases a high level of financial responsibility and stability in your finances.

You could be offered more competitive rates – Lenders may reserve some of their more competitive home loan offers for borrowers with smaller loan-to-value ratios (LVRs). An LVR is the difference between the amount borrowed through the home loan and the value of the property, expressed as a percentage. Saving a 20% deposit means your LVR is 80%, and home loan lenders may reserve their lowest interest rates for borrowers with LVRs at 80% or below. Having a smaller deposit may mean you’re likely to be offered higher interest rates due to the perceived risk you may be more likely to default.

You’re more protected from negative equity – If you purchase a property with a smaller deposit and the purchase prices falls, you may run the risk of being in negative equity. In fact, RateCity research shows that if you purchased a home in Sydney in December 2021 with a deposit of only 5%, if property prices continue to fall, by the end of 2023 you could owe the lender 15% more than what the property is worth. Saving a higher deposit may put you in a better financial position if property prices decline.

Larger deposits mean less debt and smaller repayments– Put simply, the more you save up for a deposit the less debt you will owe to a lender. The less you owe and the lower your home loan amount is, the lower your home loan repayments will be. By saving up only a 5% deposit you’ll be likely increasing the amount you’ll make in monthly repayments compared to if you saved up a 20% deposit, as you’ll have a larger mortgage.

How do you get a 5% deposit home loan?

If you’re hoping to purchase a home without saving up a large deposit, you’ll want to ensure you do your research around your best home loan options. You should be able to find home loan options for 10% deposits (90% LVRs), such as Reduce Home Loans Rate Lovers Cashback home loan.

A 5% deposit home loan may be a little harder to find, and this is often for your benefit as they can pose some risks to borrowers, as explained above. That being said, some lenders may be willing to offer home loans to borrowers with 95% LVRs, so it’s worth shopping around.

Another strategy home buyers can consider is utilising the aforementioned government home buyer assistance schemes, including:

  • First Home Loan Deposit Scheme (FHLDS) – The federal government acts as a guarantor on your home loan, allowing you to purchase an existing dwelling with a deposit of as little as 5%, without paying Lender’s Mortgage Insurance (LMI).
  • New Home Guarantee – The federal government acts as a guarantor on your home loan for a new property purchase, with a deposit of as little as 5%, without paying LMI.
  • Family Home Guarantee – The federal government acts as a guarantor on a home loan for single parents only, allowing you to purchase a property with a deposit of as little as 2%, without paying LMI.

Another factor home buyers should consider when trying to nab a home loan with a smaller deposit is how their credit score factors into this. A lender will look at their credit history and perform a hard credit check when applicants apply for a home loan. By assessing an applicant’s financial situation and history, a lender gains a deeper understanding of their likelihood to default on the loan.

Borrowers with excellent credit scores may be more likely to gain home loan approval full stop. So, if you’re trying to nab a home loan with a smaller deposit, ensuring your credit score and credit history is in a healthy range could improve your chances of gaining approval.

Finally, it may be worth ensuring that even if you have a smaller deposit, you’re still showcasing a history of genuine savings. Genuine savings simply mean money you have saved up over a period of time, such as 3-6 months.

Lenders may look through your bank statements to see you have genuine savings before approving your home loan application. If you saved your smaller deposit in a very quick turnaround, it may be worth holding off on applying until you’ve made a few more regular deposits into your savings account.

Whether you choose to save up a larger deposit or try to get by with a smaller deposit, ensuring you’re applying for the best home loan for your financial situation and budget is crucial. Just because you have a smaller deposit of, say, 10%, doesn’t mean you should have to pay the highest interest rates in the market. Compare factors like the interest rate, fees, and features offered so you’re getting the best bang for your buck.

Reduce Home Loans offers some of the most competitive rates for borrowers with 90% LVRs. Compare some of our tailor-made first home buyer loans today to see how much you could save with Reduce Home Loans.

 

Any statements are general in nature and do not take into account your financial personal situation, objectives or needs. You should consider whether any statement/s is suitable for you and your personal circumstances. Before making any financial decision, consider your circumstances and the product disclosure statement.

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(29)    For the Rate Cutter Variable where the borrower pays $1170 upfront fees then a corresponding loyalty discount of 0.10% p.a. off the Rate Cutter Variable (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(27)    For the Investor Rate Slasher Cash Back Variable where the borrower pays $0 upfront fees then a corresponding loyalty discount of 0.06% p.a. off the Investor Rate Slasher Cash Back Variable (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(26)    For the Low Rider Cash Back Variable where the borrower pays $0 upfront fees then a corresponding loyalty discount of 0.06% p.a. off the Low Rider Cash Back Variable (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(25)    For the Economizer Cash Back Variable where the borrower pays an upfront fee of $697 then a corresponding loyalty discount of 0.08% p.a. off the Economizer Cash Back Variable (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(24)    For the Super Saver Cash Back Variable where the borrower pays an upfront fee of $697 then a corresponding loyalty discount of 0.10% p.a. off the Super Saver Cash Back Variable (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(23)    For the Super Saver Variable where the borrower pays an upfront fee of $1170 then a corresponding loyalty discount of 0.15% p.a. off the Super Saver Variable (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(22)    For the Economizer Variable where the borrower pays an upfront fee of $1,170 then a corresponding loyalty discount of 0.11% p.a. off the Economizer Variable (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(21)    For the Investor Cash Back Hero Variable where the borrower pays an upfront fee of $697 then a corresponding loyalty discount of 0.08% p.a. off the Cash Back Hero Variable (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(18)    For the Home Owners Dream 1 year fixed where the borrower pays an upfront fee of $697 then a corresponding loyalty discount of 0.20% p.a. off the Home Owners Dream reverted variable rate (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(20)    For the Cash Back Hero Variable where the borrower pays an upfront fee of $697 then a corresponding loyalty discount of 0.08% p.a. off the Cash Back Hero Variable (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(14)   For the Investor Rate Slasher where the borrower pays an upfront fee of $1,170 then a corresponding loyalty discount of 0.09% p.a. off the Investor Rate Slasher rate (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(12)   For the Investor Rate Lovers Interest Only where the borrower pays an upfront fee of $697 then a corresponding loyalty discount of 0.07% p.a. off the Investor Rate Lovers Interest Only rate (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(11)   For the Wealth Maximizer 3 year fixed Principal & Interest where the borrower pays an upfront fee of $697 then a corresponding loyalty discount of 0.20% p.a. off the Wealth Maximizer reverted variable rate (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(10)    For the Wealth Maximizer 2 year fixed where the borrower pays an upfront fee of $697 then a corresponding loyalty discount of 0.20% p.a. off the Wealth Maximizer reverted variable rate (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(9)    For the Home Owners Dream 3 year fixed where the borrower pays an upfront fee of $697 then a corresponding loyalty discount of 0.20% p.a. off the Home Owners Dream reverted variable rate (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(8)    For the Home Owners Dream 2 year fixed where the borrower pays an upfront fee of $697 then a corresponding loyalty discount of 0.20% p.a. off the Home Owners Dream reverted variable rate (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(7)    For the Investor Rate Slasher where the borrower pays an upfront fee of $1,170 then a corresponding loyalty discount of 0.09% p.a. off the Investor Rate Slasher rate (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(6)    For the Investor Rate Buster Variable where the borrower pays an upfront fee of $697 then a corresponding loyalty discount of 0.08% p.a. off the Investor Rate Buster Variable rate (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(5)    For the Rate Buster Variable where the borrower pays an upfront fee of $150 then a corresponding loyalty discount of 0.05% p.a. off the Rate Buster Variable rate (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(4)For the Rate Slasher Variable where the borrower pays an upfront fee of $1,170 then a corresponding loyalty discount of 0.08% p.a. off the Rate Slasher Variable rate (at that time) will automatically apply after the 5th anniversary of the loan. These fees and loyalty discount are factored into the comparison rate. The loan setup fees are not refundable.

(3) For the Investor Rate Lovers Variable where the borrower pays $0 upfront fees then a corresponding loyalty discount of 0.06% p.a. off the Investor Rate Lovers Variable rate (at that time) will automatically apply after the 5th anniversary of the loan. These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(2)For the Rate Lovers Variable where the borrower pays $0 upfront fees then a corresponding loyalty discount of 0.06% p.a. off the Rate Lovers Variable rate (at that time)  will automatically apply after the 5th anniversary of the loan.  These fees and loyalty discount are factored into the comparison rate.  The loan setup fees are not refundable.

(1) For the Low Rider Variable where the borrower pays $0 upfront fees then a corresponding loyalty discount of 0.06% p.a. off the Low Rider Variable rate (at that time) will automatically apply after the 5th anniversary of the loan. These fees and loyalty discount are factored into the comparison rate. The loan setup fees are not refundable.

(28) For the Rate Crusher 1 Year Fixed where the borrower pays an upfront fee of $697 then a corresponding loyalty discount of 0.05% p.a. off the Rate Crusher reverted variable rate (at that time) will automatically apply after the 5th anniversary of the loan. These fees and loyalty discount are factored into the comparison rate. The loan setup fees are not refundable.

(19) For the 1 Year Fixed Wealth Maximizer where the borrower pays an upfront fee of $697 then a corresponding loyalty discount of 0.20% p.a. off the 1 Year Fixed Wealth Maximizer reverted variable rate (at that time) will automatically apply after the 5th anniversary of the loan. These fees and loyalty discount are factored into the comparison rate. The loan setup fees are not refundable.