Want to buy a house? For first home buyers battling to get into Australia’s competitive property markets, 95 per cent home loans can offer a doorway in. But borrowers should do their homework before entering such arrangements.
Low and no-deposit home loans hit the peak of their popularity in August 2008, when 86 per cent of mortgage products offered a loan-to-value ratio (LVR) of 95 per cent or higher.
Add a global financial meltdown to the mix, and banks became more cautious – mortgage products with high LVRs dropped significantly. By August 2010, they were just 49 per cent of home loans.
But in recent years, as the property market has heated up, the low-deposit home loan has been making a comeback. Since August 2011, about 70 per cent of mortgages in RateCity’s database have an LVR of 95 per cent or above. The financial comparison website monitors 2900 home loan products, covering all major brands. Of those, 109 have an LVR of 97 per cent or above. RAMS offers a 100 per cent home loan, but only with a guarantor.
As Alex Parsons, chief executive of RateCity, observes: ”It’s tough for first-home buyers because they are trying to save money, and the interest rates for savings are very, very low; property prices are going up and therefore these products with high LVRs are very, very attractive to first-home buyers.”
Ben Turner, 31, and his wife, Alex Kiel, 29, opted for a 95 per cent home loan, after unsuccessfully trying to break into the Sydney property market.
”We’d looked for a few years and we were always saving our money because we knew that we wanted to get into the market because it was such a good investment,” Turner says. By the end of last year, they were facing a ”now or never situation”.
”We saw the places that we were once able to afford easily were now out of our reach. We missed out on a few properties at auctions … so we downsized what we actually wanted and went with an investment.”
Instead of buying a house in Sydney’s Inner West, they settled on an Eastern Suburbs apartment, close to where they are renting. If you’re thinking of following the couple’s lead, here are four questions to weigh up.
Can you cope with interest rate rises?
Parsons urges borrowers to bear in mind that interest rates are at historic lows. ”Make sure that you can afford a few interest rate increases in the future without putting yourself into mortgage stress.”
The Australian Prudential Regulation Authority (APRA) issued a similar warning in September last year, after seeing an increase in low-deposit mortgages. It said: ”It is important for [authorised deposit-taking institutions] to ensure that new borrowers are able to service debt and afford higher repayments when interest rates rise from current low levels.”
It stopped short, however, of following New Zealand’s example, where banks have to restrict new residential mortgage lending at LVRs of more than 80 per cent to no more than 10 per cent of the value of their new housing lending flows.
Do you look good on paper?
Lenders can be choosy. Jessica Darnbrough, head of corporate affairs at Mortgage Choice, says: ”[Lenders] have put in all these rules and regulations for themselves so that they avoid dealing with people [who] will perhaps default on their mortgage.”
People who have recently paid off large debts are less likely to get a low-deposit loan. More likely is the university graduate who has walked straight into a high-paying job.
How did you get your deposit?
When your deposit is small, its make-up is crucial. Darnbrough says lenders like to see genuine savings. ”Some lenders, like St George, will let you show rental payments as evidence of genuine savings, but generally a lender will like to see 5 per cent, or in the case of these low-deposit home loans, 2 or 3 per cent in genuine savings.” You need to be able to show you’ve saved regularly, or held on to a gift or a bonus for at least three months, sometimes longer.
Can you afford the lender’s mortgage insurance?
Taking out a low-deposit home loan has a knock-on effect: lender’s mortgage insurance. It protects the lender if the borrower defaults. The premium – between 2.65 per cent and 3.3 per cent of the loan – can be paid as a lump sum or via your repayments. You may have to pay it twice (see breakout). If you don’t qualify for a low-deposit home loan, or want to avoid mortgage insurance, what’s your best alternative? Keep saving. Watch out for insurance trap
Beware – lender’s mortgage insurance can strike twice.
If you refinance before you have 20 per cent equity in your property, you will cop another hit of lender’s mortgage insurance (LMI).
Mortgage Choice’s Jessica Darnbrough says most people refinance after three to five years, and LMI isn’t transferable between one lender and another.
Even if you refinance to another product with your existing lender, you may have to pay the premium again. Risky lending
Home loans with LVRs of 95% and above (deposit of 5% or less)
March 2014 – 70% (% of RateCity’s database)
February 2014 – 69%
January 2014 – 69%
August 2013 – 73%
August 2012 – 68%
August 2011 – 69%
August 2010 – 49%
August 2009 – 59%
August 2008 – 86%
Source: ratecity.com.au, data accurate as at March 27, 2014