It is unlikely that even Treasurer Jim Chalmers would have believed how quickly some action would eventuate on his Budget promise to deliver intergenerational equity by overhauling negative gearing and the capital gains tax discount.
The negative price action since May 12 has certainly affirmed Chalmers’ hope that forcing investors out would help first home buyers in, although the price falls in the big cities of Sydney and Melbourne have not been as large at the more affordable end of the market.
Nevertheless, there is certainly a lot more activity in the first home buyer market, with one of the remaining roadblocks being the ability to save a big enough deposit and potentially avoid paying the dreaded lenders mortgage insurance (LMI).
There are good reasons to avoid paying LMI other than a reluctance to buy insurance that protects the lender rather than the person paying the hefty premium, which is often inflated further by being added to the mortgage.
Saving for a Deposit Never Harder
The main one is that saving a big deposit is really tough amid a cost-of-living crisis and with rents remaining stubbornly high.
It also means spending many years of saving which can get tedious, particularly if property prices happen to be rising quickly which simultaneously increases that deposit target.
Fortunately prices are now softening so that is not a current problem but what is often missed is that there are some great strategies for buying property without reaching a 20% deposit that could help some first home buyers into what has over decades become a really tough market to break into.
Of course, buying before having a 20% deposit increases debt repayments so you need to be sure you have enough income to pay the mortgage and any likely interest rate rises.
If that measure of affordability is met, there are solutions to increase accessibility by having enough cash up front to buy a property.
Options Without a Full Deposit
So, what are some of the options for savers who want to pull the trigger before saving a full 20% deposit?
The first step is to investigate the two main programs set up by the Albanese government – the 5% Deposit Scheme and the Help to Buy Scheme – to see whether they can help you.
As the name suggests, the 5% Deposit Scheme allows buyers to use a deposit as small as 5% of the property’s value and waives LMI.
The good news here is that there are unlimited spots available for this scheme and also no limit on how much you can be earning to use the scheme.
The price limits for eligible properties have also been increased for most cities, although they are obviously still a limitation on how much can be spent.
Stick to What You Can Afford
The big questions to answer then are not how much the bank will lend you under the scheme but how much your Budget can pay—factoring in a couple of interest rate rises for good measure.
The mortgage payments will be big and the loan will be big too but if you are confident of meeting your Budget, using this scheme can be a great benefit.
It also avoids that feeling of the goalposts always moving as you are saving—for good or ill you will be in the property market, hopefully for the long haul.
It is also worth remembering that when you buy a property you have two investments to manage: the property and the mortgage.
Mortgages can be discouraging in the early years because almost all of the repayments go towards repaying interest and very little goes towards repaying the loan principal.
It is not a bad idea to have some sort of longer-term plan to accelerate the loan repayment a little.
Even small extra repayments of principal made frequently can make a big dent in the length of a mortgage and the total interest paid.
Many borrowers also find that an offset account can be worthwhile, although you need to ensure that making enough use of the account to save interest is worth more than the extra cost that comes with this sort of account.
Shared Equity Can Be Effective
The Help to Buy Scheme, which first became available in December, is a shared equity scheme where the government covers up to 30% of the purchase price of existing homes, and up to 40% for new builds.
While the buyer only needs to contribute a minimum 2% deposit, they then share ownership and future capital growth with the government.
The government expects that its equity share will be paid back, either through repayments or after the property is sold.
This scheme can also help you avoid LMI as well.
It is great in the early years thanks to the lower loan and repayments but you are giving up some of the upside because the government retains part ownership.
You can buy back that government equity eventually but you need to pay the percentage of the property at its current price – not the purchase price – so the amount you need to pay can go up quite a lot if the property increases in value a lot.
Top-up Deposit Loans
Another option for those with a small deposit that is offered by some lenders is a low deposit loan.
In some cases the buyers will still need to pay LMI to get the loan although some neobanks and online lenders have offers that don’t require LMI.
One is Ubank, for example, which launched owner-occupied and investor loans where borrowers can put down a 10% deposit without taking out lenders mortgage insurance.
This sort of offer can come without some of the restrictive conditions like price caps and eligibility criteria of the government schemes although like most home loans, they tend to have higher interest rates when deposits are small.
Still, if housing prices resume their upward march at some stage, having got into the market earlier can be an advantage compared to sitting on the sidelines and continuing to save.
Another tactic which became very popular back in the bad old days of 17% interest rates is the so-called cocktail loan.
In those days the bank would happily give you a “protected” 13.5% home loan but only for part of the purchase – the rest needed to be borrowed through a cocktail personal loan at a much higher interest rate.
It was a tough answer to a specific problem that no longer exists – regulated maximum home loan rates – but it did come with the advantage that the cocktail personal loan could be repaid faster to rapidly reduce the effective overall interest rate.
Now such loans are usually called deposit boost loans and they act like a second mortgage that must be paid at the same time as the home loan.
‘Bank of Mum and Dad’ FTW
Alternatively, a cocktail loan or grant could be negotiated with the ever more popular “Bank of Mum and Dad”, although the eventual home lending bank will probably want a letter to define whether the loan needs to be repaid or not.
The benefit of getting to the 20% deposit through one of these methods is not only not having to pay LMI—there should also be a lower interest rate on the home loan.
Another alternative is for the Bank of Mum and Dad acting as guarantor for the home loan, usually by posting some security in the form of an asset such as their home.
Of course, access to the Bank of Mum and Dad is not available to everybody and it can be dangerous for all parties in a financial and relationship sense.
Both sides need to be really confident that the arrangement is durable and won’t threaten their standard of living should things go wrong, so it is not to be taken lightly.
