Saving for a home deposit is never easy, especially if you’re a first home buyer living in a more expensive city, like Sydney or Melbourne.
And with most financial advice recommending saving up a deposit of at least 20 per cent, you may be wondering if you can still buy a property with a 5 per cent deposit.
Aiming for a 5 per cent deposit instead of a 20 per cent deposit may mean a difference of years spent waiting for the keys to your dream property. And with the housing market starting to heat up again thanks to eased Covid-19 restrictions, some borrowers may be feeling the pressure to nab a property as soon as possible.
But a 5 per cent deposit comes with its own risks and added costs, even if it may save you skipping another evening out to save money. And the information available can feel conflicting when the First Home Loan Deposit Scheme helps would-be borrowers get a mortgage with a 5 per cent deposit.
Let’s take a look at everything you need to know about buying a property with a 5 per cent deposit.
The real cost of 5% home loan deposits
Whether you’re keen to get a property as soon as possible, or you’re not sure saving a 20 per cent deposit is realistic with your budget, there are a few things to consider with a smaller deposit loan.
Lenders mortgage insurance
One of the best arguments a lender can make to encourage borrowers to saving a bigger deposit is that they can avoid paying costly Lenders mortgage insurance (LMI). This is an insurance that the borrower will have to pay if their home loan deposit is under 20 per cent, as you’re seen as a riskier borrower to the lender.
This is typically calculated based on your loan-to-value ratio (LVR), which is a measurement of your loan size versus the value of the property. If you opted for a 5 per cent deposit, your LVR would be 95 per cent, meaning you’re borrowing 95 per cent of the value of the property. Lenders mortgage insurance is charged for borrowers with LVRs over 80 per cent, and can cost tens of thousands of dollars.
While it doesn’t need to be paid upfront and can be added to the loan amount, this will still significantly increase the total cost of the loan due to interest repayments. This means that while a 5 per cent deposit may take less time to save for, it’ll potentially cost you more in the long run.
Your debt is higher
It’s not hard to understand why lenders may be uneasy about your ability to repay a home loan with a deposit this small. The bigger the debt, the greater your chance of falling into mortgage stress or even defaulting.
It’s worth looking into your potential home loan repayments with a Mortgage Repayment Calculator to see just how much more you’ll be paying each month with a bigger loan size. Saving up a bigger deposit helps to reduce your ongoing repayments and the amount of interest you’re charged over time.
Less likely to be approved
Unless you’ve found a specialty lender or are using the First Home Loan Deposit Scheme, you are less likely to be approved for a mortgage with a deposit this small. This is in your best interest, as taking on debt you may not be able to afford is financially risky.
Lenders look more favourably on borrowers with deposits of at least 10 per cent, as it shows a greater level of financial discipline. Plus it helps to prove your “genuine savings” on your application, as lenders will look to see if you’ve squirrelled away a regular amount in a savings account over at least three months.
Your rate may be higher
Another downside of saving up a smaller deposit is that lenders may be less likely to offer you their most competitive interest rates.
Lenders may stipulate in their terms and conditions that their lowest rate offerings are reserved for borrowers with LVRs of 80, 70 or even 60 per cent. If you’ve only saved a 5 per cent deposit, while a lender may still approve you, you may be offered a higher rate to begin with. Higher interest rates ensure a lender gets some funds back from borrowers who are considered “riskier”.
Keep in mind that once you’ve paid down some equity you’ll be in a better position to negotiate a more competitive rate.
The First Home Loan Deposit Scheme
First home buyers may potentially be able to get a foot on the property ladder with a smaller deposit, thanks to the First Home Loan Deposit Scheme (FHLDS).
This scheme was created to help first home buyers get a home loan with a deposit of at least 5 per cent of the property value. Normally a borrower would have to pay LMI with a 5 per cent deposit. But the FHLDS guarantees the lender the remaining 15 per cent of funds to get to a 20 per cent deposit.
However, it’s still worth considering all of the risks and costs associated with smaller deposits mentioned above. You’ll be more likely to pay higher mortgage repayments than if you saved for a bigger deposit. Plus, you may end up paying tens of thousands of dollars more in interest over the life of the loan.
If you’re unsure if your budget can afford the mortgage repayments associated with a 5 per cent deposit, a Budget Calculator can come in handy here.
Do lenders still approve borrowers with a 5 per cent deposit?
Just because it has its drawbacks, doesn’t mean that you can’t still nab a home loan with a 5 per cent deposit. As long as you go into the application process with a clear understanding of the above risks, it may still be worth considering this route.
Consider boosting your chances of being approved before you apply for a home loan with a 5 per cent deposit in the following ways:
- Make regular savings (for at least three months).
- Ditch Uber Eats, Afterpay and other discretionary spending for the months leading up to your application.
- Pay off all your other debts, including outstanding credit cards and potentially even your HECS/HELP debt.
- Work on increasing your credit score if you’ve struggled with bad debts and defaults in the past.
Contact a Reduce Home Loans Finance Manager to determine your best option on 1300 733 823 or drop us a message today.