28 November 2019

Is a Low Deposit Loan Right for You?

Vic Lorusso
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Want to buy a home but don’t have the 20% deposit? A low deposit home loan could be the ideal way to fast-track your home ownership dreams – but there’s a catch: this type of loan tends to be riskier, more expensive and harder to get.

Despite that, over a fifth of new loans during the June Quarter of 2019 were to low deposit borrowers, according to APRA data.

What are the advantages of a low deposit home loan?

A loan is defined as being low deposit when the deposit is less than 20% of the principal (the total loan amount). The advantages of securing such a loan are obvious – you don’t have to save as much to buy your home and can therefore buy sooner without scrimping and sacrificing to save a big deposit.

Such loans are tempting for young home buyers in particular, who face a huge task to break into an increasingly unaffordable Australian property market.

Are there risks involved?

Unfortunately, low deposit loans aren’t all sunshine, rainbows and free money. First of all, securing such a loan can be difficult since they’re deemed to be high risk by most banks and lenders. You’ll need a good credit score and a solid, reliable income to be considered.

Secondly, low deposit loans can be expensive. You’ll have to pay Lenders Mortgage Insurance: a one-off fee that insures the lender in the event that you fail to make repayments and default on your loan. This can cost more than $10,000 or even $15,000 for a $500,000 loan, but can be added to your total home loan amount (capitalised).

Since low deposit loans are deemed to be riskier than normal mortgages, they also usually come with an interest rate that can be a full 1% or even 2% higher. Since your principal amount and your interest rate is higher you may take longer to pay your loan off, find it difficult to make repayments and pay far more interest than if you’d secured a normal loan.

Is a low deposit home loan right for you?

Before you lock in a low deposit loan you need to fully understand what the risks are and what they mean for you. With the help of a registered financial advisor or mortgage broker, you should take a close look at your finances so that you’re absolutely sure you can meet repayments now and in the future. Generally speaking, the amount of your mortgage repayments should never exceed 30% of your total take home income.

You should also consider whether you could spend another year or two saving so that you can accumulate a 20% deposit. Spending more time renting or living at mum’s place might sound like a nightmare, but by doing so you could save yourself tens of thousands of dollars in the future.

Last of all, if you’ve decided to go with a low deposit loan you should consider your exit plan. Once you’ve amassed 20% of equity in your home you may be able to refinance for a lower interest rate, lower fees and better terms.

A low deposit loan may be a great way to get into a home sooner, but there’s always a catch. They can be expensive, risky and difficult to secure. That’s why if you’re considering buying with less than 20% you need to fully understand the downside of low deposit loans and seek professional advice to make sure you’re making the right decision.

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