We all know that saving a deposit in the first place can be a challenge for some, but it could be worth going that extra step and making sure your deposit amount is as large as it can be.
Not only can having a decent deposit save you from financial crisis further down the track, but it can also help save you from paying additional fees and charges because your LVR means you have to pay LMI. Allow me to explain.
If only Lehmann Brothers, Fannie Mae and Freddie Mac et al had remembered the old saying from one of America’s founding fathers Benjamin Franklin: “ a penny saved is a dollar earned”.
These banks deemed “too big to fail” brought about the Global Financial Crisis by lending money – sometimes more than 100 per cent of the value of the property – and then threw in extra for a new car or a plasma TV to people who had no deposit, no jobs and no way of paying it back.
In Australia, our banks are regulated much more heavily than in the US and as a result, we have managed to avoid the situation the US finds itself in.
The benefits of saving as much money as possible in order to have a large deposit when buying a home are substantial, as you can avoid a number of additional fees and charges.
Loan to Valuation Ratio (LVR)
The Loan to Valuation Ratio or LVR is an important criteria used by lenders to evaluate your suitability to borrow.
It is a formula they have devised based on experience of loan defaults that attempts to minimise risk from borrowers defaulting.
The LVR is expressed as a percentage and calculated by taking the amount of the loan, dividing it by the value of the property, and then multiplying it by 100.
For example, a 450,000 loan on a $600,000 property would have an LVR of 75 per cent.
Be aware that the value of the property is determined by the lender’s valuer and is not the purchase price.
Lender’s Mortgage Insurance (LMI)
LMI protects the lender in the event that you default on your loan and the outstanding value of your loan is greater than what they receive from selling the property.
In nearly all cases, if you borrow more than 80 per cent of what the lender considers to be the value of the property they will ask you to pay their mortgage insurance.
LMI is usually charged as a one-off premium and is calculated on a sliding scale. That is, the greater the percentage of the property value you borrow and the more money you borrow, the higher the mortgage insurance premium payable.
Reducing the Principle
Naturally, a bigger deposit means you have to borrow less, which should mean you can pay off the loan faster.
For example, let’s compare two scenarios:
Jack and Jill save all of their pennies and have $150,000 deposit for their new apartment, which costs $400,000.
Their LVR is 62.5 per cent, meaning they avoid LMI.
They have an interest rate of 7 per cent, taken over 25 years. Their monthly repayments will be $1705.44 per month. Over the life of the loan they will pay $363,958.00* in interest payments.
Their friends Donald and Daisy also find their dream apartment, which also costs $400,000. However, they only have $50,000 for a deposit, meaning their LVR is 87.5 per cent and they will be liable for LMI.
According to Genworth, one of Australia’s leading LMI companies, Donald and Daisy will be up for a LMI payment of $4165.
Based on a $350,000 loan at the same interest rate over the same term, their repayments will be $2387.62 per month. Over the life of the loan they will pay $509,542.00* in interest payments.
Saving extra for your deposit can be worth the effort. Whether it’s to secure your financial future, or to save on extra fees, charges and interest, there is one thing that rings true about putting together the deposit for your next property purchase: bigger is better.