It makes sense to minimise home buying expenses but it’s also smart to avoid paying more for your property than necessary. In a rising market, lenders mortgage insurance can help buyers with a small deposit purchase a home before values climb higher.
High home prices are often seen as the main problem facing first home buyers. But that’s not always the case. One in four first time buyers say difficulty saving for a deposit is their main barrier to purchasing a first home.
How lenders mortgage insurance works
There’s no doubt rising property values can continually push the goal posts further out, making it hard to build a 20 per cent deposit. But it’s possible to get into the market with far less.
In some cases, lenders will accept a smaller deposit though it will mean paying lenders mortgage insurance (LMI).
LMI typically applies if you buy a home with less than a 20 per cent deposit. It’s a type of insurance that works quite differently from other types of cover. Most notably, LMI protects the lender, not you, if you cannot keep up the loan repayments.
On the plus side, home buyers don’t have to shop around for LMI. Your lender will use their own provider and let you know the premium that needs to be paid.
The cost varies in line with a number of factors including the amount of the loan and the size of your deposit. And because it’s a one-off expense you don’t need to worry about paying a fresh LMI premium each year.
Saving a bigger deposit can lower LMI
The downside is that LMI premiums can run into thousands of dollars. As a guide, a first home buyer using a $60,000 deposit to buy a home costing $600,000 can expect to pay LMI of around $13,176. If that same buyer raises a deposit of $100,000, the LMI premium can fall to $4,300.
Either way, coming up with this sort of extra cash can be a major stumbling block for home buyers, so many lenders will let you ‘capitalise’ the LMI premium. This means adding the cost to the loan balance and paying it off gradually. The catch is that this will mean paying interest on LMI, which raises the cost over time.
Buy now or save for longer?
The conundrum for home buyers is whether to buy now with a small deposit and pay LMI, or hold off to save a larger deposit and avoid LMI altogether.
While the latter may seem like the smarter strategy, in a rising market, you could end up paying considerably more for your home by waiting to save a bigger deposit.
An example here can show how this works.
Let’s say Julie, a first home buyer based in Sydney, had $78,000 saved for her first home in June 2016. At that time Sydney’s median home price was $780,000 and with her 10 per cent deposit, Julie could have paid LMI of about $17,129. It sounds expensive, right? But let’s see what happens if Julie delays her home purchase for 12 months to grow more of a deposit.
Fast forward to end of June 2017, and Sydney’s median home price has skyrocketed to $880,000. It means Julie can expect to pay $100,000 more for the same property, yet she could have been $82,871 in front ($100,000 less the LMI premium of $17,129) by purchasing 12 months earlier with the benefit of LMI.
Beat the deposit blues
The flipside is that some markets have experienced falling property values over the past 12 months. In Perth for instance, the median property price in June 2016 was $505,000 compared to $484,000 in June 2017. It’s a similar story in Darwin where the median home value of $480,000 in June 2017 is $30,000 less than the median of $510,000 a year months earlier. This drop in values is giving buyers breathing space to save more of a deposit.
Nonetheless, as we saw earlier, property prices aren’t always the main hurdle to buying a home. For first home buyers who are currently renting for instance, saving a decent deposit can be tremendously difficult, and LMI can offer a financial lifeline that allows the dream of home ownership to become a reality sooner.
Remember too, LMI may seem pricey at the time of purchase, but chances are the long term rise in your home’s value will more than compensate for this upfront cost.
To understand how much of a deposit you need – and how LMI can get you into a first home sooner, talk to your Aussie broker.
You may also be interested in How to save on lenders mortgage insurance, 3 different types of insurance every homebuyer should know about and Real Estate FOMO? Stay engaged and motivated while saving for your deposit