A low-deposit home loan allows a borrower to finance between 80% to 95% of a property’s value. In some rare cases, lenders may provide finance for 100% of the property value. Due to rising property prices, low-deposit home loans are popular with first-home buyers in Australia.
How do low-deposit home loans work?
Low-deposit home loans use Lender’s Mortgage Insurance (LMI) to offset risk to the lender in the case of a default. The LMI required by a lender is calculated using the Loan-to-Value Ratio (LVR) of your property.
Loan-to-Value Ratio (LVR)
LVR is the amount of your loan compared to the purchase price of your home, expressed as a percentage. If you have a 20% deposit your LVR will be 80%.
Lender’s Mortgage Insurance (LMI)
If you have an LVR of less than 80%, you may need to pay lender’s mortgage insurance in order to secure a loan. This is a one-off cost that pays for insurance to cover your lender’s costs in the event you default on your loan.
When calculating the LMI you may be required to pay, a lender will consider:
- The size of your deposit
- The size of your loan principal
- The level of risk you present as a borrower
LMI can vary from as little as $1,000 to more than $30,000 depending on the above factors.
Examples of LMI cost
| Loan example 1 | Loan example 2 | Loan example 3 | |
|---|---|---|---|
Property value | $500,000 | $500,000 | $500,000 |
Loan amount | $400,000 | $450,000 | $475,000 |
Deposit amount | $100,000 | $50,000 | $25,000 |
LVR | 80% | 90% | 95% |
LMI amount | $0 | $7,920 | $15,722.50 |
Low deposit home loan vs full deposit home loan
Low deposit home loans may be more expensive than full deposit home loans. Here’s an example of what the difference may be on two comparable loans with a 3% interest rate and a 30-year loan term.
Example of low-deposit vs full-deposit home loan
| Low deposit home loan example | Full deposit home loan example | |
|---|---|---|
Property value | $500,000 | $500,000 |
Loan amount | $475,000 | $400,000 |
LVR | 95% | 20% |
Deposit size | $25,000 | $100,000 |
LMI cost* | $17,480 | $0 |
Monthly repayment size | $2,003 | $1,686 |
Total interest payable | $245,943 | $207,110 |
Total loan cost (includes principal repayments) | $763,423 | $707,110 |
Low deposit home loans for first-home buyers
Low deposit home loans are popular among first-home buyers as a way to get a foot on the ladder in the increasingly expensive Australian property market. There are a number of options available to first-home buyers who want to buy with a small deposit.
First Home Loan Deposit Scheme
The First Home Loan Deposit Scheme is a government initiative designed to help first-home buyers into the market. Under the scheme, the government will guarantee up to 10,000 low-deposit home loans a year for low and middle-income earners who fit eligibility criteria.
Buyers who are approved under the scheme will be approved for finance with a 5-20% deposit and no lenders mortgage insurance. All applications for the First Home Loan Deposit Scheme should be made through approved lenders, which include:
- NAB
- Commonwealth Bank
- Beyond Bank
- Bendigo Bank
- Regional Australia Bank
- Mortgage Port
If you successfully apply for the scheme it could save you tens of thousands of dollars over the life of your home loan.
Guarantor home loans
A guarantor home loan is a smart way to secure a low deposit home loan, and may even help you avoid paying LMI and higher interest rates.
To secure one of these loans you’ll need a guarantor - someone who is willing to help you by allowing the bank to use their property, cash as security. In most cases, guarantors are parents helping their children buy their first home.
Guarantor home loans pros and cons
Pros
- You may be able to buy a home with a 0% deposit. Some lenders may even allow you to borrow up to 105% of the property value.
- May feature discounted interest rates.
- Allows you to avoid paying LMI.
Cons
- Some lenders limit guarantor loans to first-home buyers.
- Should you default on your loan the guarantor could be liable for the full amount.
- In the worst-case scenario, the bank could sell your property and your guarantor’s property to recoup their losses.
If you’re lucky enough to have parents or immediate family members who are willing and able to guarantee your loan using their property as security this can be a great way to buy a property straight away, without all the extra costs like LMI.
Applying for a low deposit home loan
You can apply for a low-deposit home loan with the majority of lenders in Australia, such as:
- Retail banks
- Mutual banks and credit unions
- Non-bank lenders
- Mortgage broker
Applying for a low-deposit home loan may require greater documentation and preparation, as lenders often consider these types of loans riskier than standard home loans.
1. Speak to a mortgage broker
A good mortgage broker will help you improve every aspect of your application to improve your chances. They may also be able to advise you which lenders are more likely to accept your application.
2. Make the most of first-home buyer incentives and grants
There are a number of grants and incentives that aim to make it easier for first-home buyers to get on the property ladder. These include the First Home Owner Grant, which you may be able to add to your deposit. Make sure you’re aware of these incentives before you apply as they may increase the size of your deposit and decrease your costs.
3. Stay in the same job
Don’t switch jobs or industries before applying for a home loan. If you’ve been in the same job for several years that tells lenders your income is secure and you’ll be able to make repayments.
4. Clean up your spending
Your lender may request to look at up to 6 months of your bank transactions. They’ll look at your income VS spending and use what they find to help them assess your application. Spend less before you apply and your lender may be more likely to approve your application.
5. Pay off debts
Debt affects your ability to make repayments and may imply that you’re spending more than you earn. Prove to your lender that you’re financially responsible by paying off all your debt before you apply (particularly credit cards, personal loans, car loans and other high-interest debt).
6. Increase your genuine savings
Genuine savings is money you’ve earned and put aside in account yourself. It shows lenders that you can manage your finances and that you’ll be able to make repayments. The more you save, the better your application will appear.
Once you’ve secured pre-approval for your low deposit loan make sure that you keep your financial and employment situation the same. Your lender can still deny your application when it comes to formal approval if your circumstances have changed.
Summary
Thanks to high property prices low deposit loans have become increasingly common in Australia, especially among first-home buyers.
These loans are a great way to buy property sooner without saving a massive deposit, but they also come with a number of risks and extra costs, including:
- LMI
- Higher interest rates
- Higher repayments
- Higher interest cost over the life of the loan
- Difficult application process
Before buyers consider a low-deposit home loan they should be aware of all the risks and drawbacks so that they can be sure they’re making the right decision.
Low deposit home loan pros and cons
Pros
- May allow you to purchase a home sooner without saving a large deposit.
- Buying a property sooner may allow you to benefit from more capital gains if the property you buy jumps up in value. This could increase your equity.
- You may be able to switch to a cheaper loan product in future when you increase your equity in the property.
Cons
- Higher costs including LMI.
- May have higher interest rates.
- Higher principal amount, which means: Higher repayments, and more interest payable over the life of the loan.
- Your application may be more likely to be denied.
Low deposit home loan FAQ
How do low deposit home loans work?
Low deposit home loans work the same as normal home loans, although they may include extra costs like LMI as well as higher interest rates. They may also be harder to secure as lenders deem them to be higher risk.
Are low deposit home loans a good idea?
That depends on your unique situation. Low deposit home loans generally cost more than regular home loans so if you’re able to save a 20% deposit you’ll pay less interest and lower fees over the life of your loan. With that said if you have a reliable, high income, low deposit loans can be a good way to buy property sooner.
Are low deposit home loans expensive?
Low deposit home loans can be more expensive than regular home loans. That’s because they often come with a one-off cost known as lenders mortgage insurance - charged by your lender to protect them against losses if you default on your loan.
Can first-home buyers get low deposit loans?
Yes, first-home buyers can get low deposit home loans. However, lenders will only approve them if you have a solid stable income that can easily service the repayments. They may also come with extra costs like LMI and higher interest rates.
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Shaun McGowan
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