Rising house prices can make it difficult for first home buyers to save a deposit to get into the market.
This article uses an example from a major bank to demonstrate the minimum deposit needed, in this case 5% of purchase price plus the major borrowing cost, Lender Mortgage Insurance (LMI). As outlined in previous articles, LMI is payable by the borrower if the proposed loan is higher than 80% of the property’s value. While it can be a large one-off, upfront cost it does allow quick entry into the market to possibly avoid paying a higher price for a similar property if you delay the purchase to save more. However, prices can of course be flat or even reduce in certain locations, property types or market cycles. Therefore, a highly geared purchase must be an informed decision with all the facts, ability to comfortably cover your commitments and one that meets your needs and objectives. For some LMI loans lenders will require genuine savings, which means you can demonstrate a track record of being able to save the deposit and/or meet commitments such as loans or rent. The genuine savings policy is different across lenders but is an important part of the application assessment that is often overlooked.
The three main ways to reduce or avoid LMI as a borrowing cost are to receive a cash gift, sell an asset or be able to use a family guarantee. The gift needs to be exactly that, non-repayable, otherwise the lender will consider the amount to be a loan and add the repayment to your commitments. A gift will reduce the loan amount and therefore the repayments as will using the sale proceeds of an asset, for example, a boat or car that is not being used. The third way is to use a family guarantee, which is explained below.
What is a family guarantee?
A family guarantee provides additional security for the loan. It will increase the security available to the bank that can lead to reduction or elimination of the need to pay LMI. The family member/s provide a guarantee limited to the loan amount. This guarantee is supported by a mortgage over a residential property – either owner occupied or investment.
How it works
Using $545,000 as a purchase price, with $45,500 deposit and $276 government fees, we have calculated that the base loan required is $499,776 which is 91.70% of the purchase price. The LMI Premium is $13,365 is added to the loan given your total deposit has been used. The final loan amount is $513,141 which is 94.15% of the purchase price.
If a parental guarantee is provided, base loan is split into two loans:
o First loan at 80% secured by the property owned by the applicants = $436,000, and
o Second loan being the difference between base loan and 80% loan, i.e. $63,776. This loan is secured by the applicant’s property and the guarantee.
Advantages
1. A lower initial loan amount and repayments, i.e. the LMI Premium is not added to the loan.
2. LMI cost $13,365 is not paid.
3. Lower loan amount can assist with debt servicing capacity.
Disadvantages
1. Not being able to complete with your own resources.
2. Guarantor risk – the guarantor may be called upon to pay or take over the guaranteed loan amount in circumstances such as default or sale at a lower price due to circumstances such as;
3. An adverse event occurs with the borrowers, e.g. relationship break up, death of one or both borrowers, incapacity, loss of income.
4. Can restrict the guarantor should they want to sell or mortgage the property use to support the guarantee.
Providing a guarantee is a fantastic way to help a first home buyer increase their deposit. However, it is important that the family member/s providing the guarantee fully understands the risks and take their current and immediate future circumstances into account. Adequate insurance cover is highly recommended to cover these aspects.
Contact us today to tailor a quote to suit your situation or discuss the family guarantee.
Help with saving your deposit
Prior to applying for a home loan, it is important that you complete a budget in order to understand your income, workout ways to increase it, track your expenditure and reduce your personal debt . We recommend our clients use the Money Smart budget tool – see link below. The budget tool can be saved online or as spreadsheet that will help you effectively understand your income expenses and surplus, be able to budget for savings, complete projections, etc.
https://www.moneysmart.gov.au/tools-and-resources/calculators-and-apps/budget-planner
A budget will help you make your money work harder for you. Look for ways to eliminate fees such as statement fees (opt for email), ATM fees (organise how much you need and withdraw in one transaction or use EFTPOS), avoid late payments and fees (not a good look if you apply for a loan).
Contact us today to start your journey to purchasing your dream home!