Despite 2017 regulatory measures by the Australian Prudential Regulation Authority (APRA) to limit investor loans as a share of new home loans as well as the falls seen in house prices (most noticeably in Sydney and Melbourne), home ownership can still seem like a dream for many younger Australians. The Institute of Health and Welfare found in a report published in 2017 that fewer than 40 per cent of people aged 25 to 34 owned a home in 2013-14, compared with 60 per cent in 1988-89. This longterm glimpse of the market is alarming, which is why it is worth considering whether younger buyers are right or justified when deciding to buy a home with a 5 per cent deposit.
According to the Labor party’s Chris Bowen, first home buyers make up just 1 out of 7 of all home purchases in Australia. With the odds seemingly stacked so heavily against those trying to enter the market, surely entering it at any cost is worth it?
How buying a home with a 5 per cent deposit can work
Despite any falls in house prices that were seen over 2018 in the major markets, the average price of a home still creates a hurdle for buyers. A three bedroom home in Sydney’s Parramatta will still cost a family over $700,000, which if they want to buy without taking out Lenders Mortgage Insurance, requires a $140,000 deposit plus expenses. There is little wonder why Australians look towards Lenders Mortgage Insurance when buying their first home.
For those who cannot afford a 20 per cent deposit, LMI allows them to borrow more, with their lender (i.e. bank) insuring itself against the default of the loan. This means that the buyer can enter the market and benefit from longterm capital gains. For that family saving for the 3-bedroom home in Parramatta, that means they only need a $35,000 deposit to enter the market. In the longterm (30+) years, once the cost of the LMI is added to the repayments on the loan, this may work out as a worthwhile decision as long as the family able to afford living costs. Reducing the time needed to save for a deposit by 75 per cent can theoretically offset the added cost of LMI.
With that said, it is still a risky decision to make. If by entering into a mortgage you can only buy a home with a 5 per cent deposit, then by definition you should not do so. Why? Because you do not have the financial freedom to buy a home.
There are three reasons why buying a home with a 5 per cent deposit can be risky for those who can only afford this option:
- there are hidden costs of buying a home that have to be accounted for;
- you need an ongoing, healthy cash flow once you own the home and;
- the ability to account for any other changes to your finances (such as your vulnerability to a significant decline in the value of your property)
Buying a home with a 5 per cent deposit because this is all you can afford puts you at considerable risk of fluctuations in the market and changes to your circumstances (job loss, sickness etc.). If you can afford a larger deposit (10-15 per cent) then a 5 per cent deposit + LMI may be a feasible option as long as you calculate the risks and the costs thoroughly. If you have a 15 per cent deposit then why not wait and save up the extra 5%, freeing yourself from the extra cost of LMI?
When saving for a home, try to find ways to limit the time required to save for a 20 per cent deposit that means you don’t have to take out LMI. For instance, if you are saving for a home with a partner, can you both live off a sole income? Living off a sole income of $70,000 per annum and placing all of a second $70,000 income directly into savings will result in a 20 per cent deposit for a three-bedroom home in either of the two major Australian markets within 2-3 years. This does not answer the question of the stresses that come from an imbalanced debt-to-income ratio in Australia (signifying the percentage of your income that goes towards loan repayments), which is one of the highest in the world. Unfortunately, there is little that first home buyers can do to buck those trends, apart from buying cheaper houses. Reassess your goals for your first home and list any facets of a home that you are looking for (i.e. the number of bedrooms, location, aspect, style of building) and see whether there are any that can be compromised on to help you reduce that debt-to-income ratio. If you do, then buying a home with a 5 per cent deposit may again be a feasible option, as you will find yourself in less daily financial stress.