The Risks of Low Deposit Home Loans

It doesn’t seem that long ago when would-be homebuyers could take out 100 per cent loans – or even 105 per cent – to buy a property.

The GFC mostly resulted in the end of such shenanigans but there are still low deposit home loans on the market today.

The big question, of course, is whether this type of loan product is the right one for you?

So, in this article we’ll attempt to answer that question as well as outline the pros and cons of low deposit home loans.

So, what is a no deposit home loan?

A confusing aspect to no deposit home loans is that the term “no deposit” doesn’t actually mean that you don’t need a deposit.

A no deposit home loan means that you can probably borrow up to 95 per cent of the purchase price, so in reality, it’s really a low deposit home loan.

Since the GFC, the number of lenders who still offer this type of loan has reduced, so it also can be tricky to track one down.

Your guarantor’s assets are on the line

A low deposit home loan is made easier when someone else is prepared to offer up their own equity to shore up your risk profile. 

One of the most common facilities to use is a guarantor, who is a person – usually parents, family or very close friends – who use all, or a slice, of their own equity as a guarantee to your home loan.

The catch is, while they don’t have ownership rights to your property, they are also wholly and severally responsible for the home loan.

What that means is that if you can’t make your repayments, your guarantor will be responsible to meet your total mortgage commitments, even if their guarantee was only 20 or 30 per cent of the original purchase price.

In today’s high property price environment in Sydney and Melbourne, guarantor loans can also be called “the Bank of Mum and Dad“, which are becoming more popular as prospective homeowners struggle to save the necessary deposit to get a foothold in the market.

But it’s important that your guarantor not only  goes into the deal with their eyes wide open and also with the necessary financial ability to make repayments if you cannot.

But you’ll have to take out Lenders Mortgage Insurance

If you’re lucky enough to secure a guarantor for your property loan for more than 20 per cent of the purchase price, then you won’t have to pay Lenders Mortgage Insurance (LMI).

But if you don’t have a financial angel at your table, and apply for a low deposit home loan, you will most likely have to also pay LMI.

In Australia, LMI is required to be paid on home loans that have a loan-to-value ratio of less than 80/20 when purchased.

So, if you have a five or 10 per cent deposit, you’ll need to pay LMI based on the fact your deposit is less than 20 per cent of the purchase price.

The cost of LMI varies depending on the deposit and the loan amount, but generally speaking for a $500,000 loan with a five per cent deposit of $25,000, the LMI contribution will be about $15,723 extra.

Before you have a small heart attack, though, you can capitalise (or add) this to the total loan amount, so your actual home loan would be about $490,723 with the LMI attached to it.

And the interest rates are higher

Another disadvantage to low deposit home loans is the fact that they attract higher interest rates.

This is because borrowers utilising a low deposit home loan are seen as riskier by lenders because they don’t have the standard prerequisites usually required for loan approval.

Since the GFC, interest rates have been at historic lows, and while it doesn’t seem like rates will be rising quickly any time soon, they eventually will, which may result in some higher risk borrowers not being able to meet their mortgage repayments and even defaulting on their loans.

So, should I wait and save a larger deposit?

Just because low deposit home loans are available it doesn’t necessarily mean it is the right product for you.  

The thing is, if you don’t have a 20 per cent or even a 10 per cent deposit, it ultimately reduces your borrowing power and can make it more difficult to find a lender prepared to approve your loan application.

Of course, with property prices moving, it is important to try to get into the market as soon as you can but that doesn’t mean you should consider loan products that attract a host of extra fees and charges.

Perhaps, spending a bit longer saving a deposit – or receiving a gift of cash from your parents to help get you to that magical deposit number of 20 per cent – is a better option.

That way you will be seen as more attractive to lenders and will likely have a favourable outcome to your loan application.