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.
“A penny saved is a penny earned”
If only Lehmann Brothers, Fannie Mae and Freddie Mac had had remembered the old saying from one of America’s founding fathers Benjamin Franklin: “ A penny saved is a penny 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 – to people who had no deposit, no jobs and no way of paying it back. Of course, when these people defaulted (and they did in very large numbers), chaos ensued.
Australian 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.
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 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% LVR.
Be aware that the value of the property is determined by the lender’s valuer and not the purchase price.
Your LVR can also determine whether you have to pay LMI on your next home loan.
Lender’s Mortgage Insurance (LMI)
Lender’s mortgage insurance 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 percent of what the lender considers to be the value of the property they will ask you to pay lender’s mortgage insurance. Some lenders require the borrower to pay the lender’s mortgage insurance at LVR ratios less than 80 per cent.
Lender’s mortgage insurance 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
A larger deposit means you have to borrow less, which should mean you can pay off the loan faster, potentially saving thousands and years off the life of the mortgage.
Mickey and Minnie save all of their pennies and have $150,000 for a deposit for their new apartment, which costs $400,000. Their LVR is 62.5%, meaning they avoid LMI.
They have an interest rate of 7.25%p.a, taken over 30 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% and they will be liable for LMI.
According to Genworth, one of Australia’s leading Lender’s Mortgage Insurance 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.