‘Huge trade-off’: how home buyers trying to get into market sooner are blowing up their housing costs

Home buyers trying to get into the market sooner are unwittingly adding at least $5500 to their annual repayments with a loan option that finance experts warn is “risky”.

Booming prices have created a dilemma for homebuyers.

With prices surging on a near weekly basis, many home seekers have had to weigh up whether it’s better to purchase with a smaller deposit to get into the market sooner.

The alternative, and more traditional option, would be to keep saving for a 20 per cent deposit. The danger is that the sum they’ll need keeps changing and they could wait years to catch up. The result is paying a much higher price.

Buying with a smaller deposit also has risks. Buying with less than 20 per cent will incur pricey lenders’ mortgage insurance, which is a once-off charge capitalised into the loan.

Those with smaller deposits also tend to be more exposed to fluctuations in the housing market. It might make sense when prices are rising but, were they to fall, the buyer would be in danger of having a mortgage worth more than their home.

With this in mind, we’ve spoke to the experts for their advice on how to navigate their loan options and decide what size deposit they need:

LOOKING TO THE FUTURE

Advanced Property Strategies director Nhan Nguyen has made a career out of buying houses with little or no money down. He said buyers should keep in mind that there was no telling what the market would do down the track and it was unwise to assume prices would keep increasing.

Smaller deposits can be more expensive in the long run.

“Market growth in not in your control,” he said.

“You don’t want to put yourself in a position where you have to rely on price growth to make the purchase work.

“It’s easy to look at recent growth and assume you’re going to miss out unless you buy soon but it’s impossible to know that. When you buy with a smaller deposit banking on rises you are speculating.”

Mr Nguyen said buyers should try not to focus on their short-term needs and keep the bigger picture in mind.

“You don’t want to be buying just for the sake of it, it has to be the right property. Even in a softer market it could be that deal that’s one in every hundred. It take works to find something worth buying.”

ADDING VALUE

Mr Nguyen said the best properties to buy with smaller deposits were established houses with scope to improve through a cosmetic renovation. The renovation meant those with a smaller deposit could add value to the property and put themselves into a better equity position. But there was a catch.

A renovation can take the risk out of a smaller deposit.

“You need money for a renovation,” he said.

“If you don’t have the money, borrowing from friends or family is your best bet. There is no real other way around that.”

Mr Nguyen said another way to make the purchase safer was to buy under the market value. This usually meant buyer a property where the vendor valued a speedy sale over a higher price.

“You have to know agents to get these deals and they are harder to find. But at least you have some equity from the beginning.”

ADDED COST OF LOW DEPOSIT

Canstar group executive Steve Mickenbecker said those who bought with smaller deposits should not underestimate the added cost of lender’s mortgage insurance (LMI).

Economic modelling by the comparison group showed having to pay the insurance would add about $5500 to the annual cost of a loan for someone purchasing a $700,000 property. These costs would increase substantially for pricier properties.

“Over many years it really starts to add up,” Mr Mickenbecker said. “No one has a crystal ball that can see what the market will do so you have to go in knowing exactly how much buying earlier with a smaller deposit will add. A lower deposit means a bigger loan and you have to wrap the cost of LMI into that. You also might not qualify for a better loan rate, so you have to pay more interest.”

Lenders mortgage insurance could add significantly to the repayments.

Mr Mickenbecker said these costs needed to be considered against the history of price movements. “Prices do historically go up over the long-term so there is a risk in being too cautious with a deposit. I can understand why you’d make the call to buy sooner, but we’re advising people to do it with their eyes wide open. There’s a huge trade-off.”

PERSONAL CIRCUMSTANCES

Mr Mickenbecker said the personal financial position of each buyer added a complicating factor to how they should assess the deposit hurdle.

“Loans can be marginal in two ways: on the deposit and on the repayments,” he said. “If servicing the repayments on your income is going to be a stretch, a small deposit will be even more problematic and the bank shouldn’t actually be issuing the loan. But ultimately, the most important thing is being able to keep repaying the monthly amount. As long as you do that, prices can drop interest rates will rise, and you’ll be fine. Borrowing more than you can afford is the biggest risk.”