A few basics to buying a home I believe everyone needs to know!
How Much Money Do I Need For A Deposit?
Unfortunately, the answer is, it depends. In an ideal world, you would have saved up enough money for a 20% deposit, as well as for fees like stamp duty, conveyancing, building and pest inspection etc. These days, house prices are sky rocketing, so a 20% deposit could be entering six figures. This isn’t always achievable, and therefore you can buy a home with a deposit that is less than 20%. However, this comes at a price, and that price is Lenders Mortgage Insurance (LMI) and larger repayments.
LMI will be added if your deposit is less than 20%. This protects the bank (not you) if you fail to make your payments or end up owing more than what the house is worth. LMI increases the lower your deposit is, so if you only have a 5% deposit, you will be paying quite a bit more just in LMI.
Therefore, to avoid paying LMI, you have a few options. First, is to have a 20% deposit. If this isn’t possible, you could use a guarantor. This could be your parents, or grandparents, who are happy to put their home up for collateral for yours. This means, you can buy with only 5% and not pay LMI, however if you fail to pay your guarantors home can be taken by the bank as payment. You can also use the FHLDS which means the government acts as your guarantor, however there are limited spots available per year.
It is also important to remember that there are other fees associated buying a home. You may have savings worth 20% of the house, but fees like stamp duty and conveyancing could eat into your savings and leave you with a much smaller deposit.
Using the calculators on realestate.com.au, to buy a house for $450,000 with a 20% deposit, you would need $115,000, which is actually 25.6% of the purchase price.
Using this example, you would need to save more than 20% to avoid LMI, plus then also have some money to keep aside for an emergency fund.
The larger your deposit, the smaller your loan will be and therefore the cheaper your repayments will be. This is another thing to consider and is demonstrated in the screenshots above.
How Much Can I Afford to Borrow?
Arguably, serviceability is more important than your deposit amount. Serviceability basically means your ability to pay back the loan. The banks used to be very lax on this, however have tightened things up as the years have gone on. Your income, evidence of savings, and job security are all large factors in banks determining your serviceability. Those with inconsistent incomes, casual employment, or self employment may find it more difficult to get a loan as it is hard to prove you will have what it takes to pay back the loan over the next 30 years. While it is possible to still get a loan in these situations, it will just take a bit more work and would be definitely worth seeing a mortgage broker for help applying for a loan.
There are many online calculators that you can use to see how much you can borrow. While these aren’t completely accurate, they will give you a rough guide. At the end of the day, it will come down to what you are comfortable paying. Most financial gurus will say you want to keep your mortgage payments below 30% of your post tax income. For example, if you take home $1000 a week, you wouldn’t want your mortgage repayments to be any more than $300 a week. Anything over this is generally considered mortgage stress, as you also have to pay for bills, rates, and other general life expenses. Some people may be comfortable spending more than this as a good home is important to them, while some others may not want to spend more than 10%. Again, it is up to the individual and what is comfortable.
Keep in mind when looking at these calculators, that interest rates are at an all time low and will inevitably rise in the next few years. Therefore, when using these calculators it is important to factor in these rises to ensure you will still be able to afford your repayments in years to come.
$500,000 loan at 3% interest rate: $1,976 monthly repayments
$500,000 loan at 5% interest rate: $2,684 monthly repayments
There is a difference of $708 per month or $177 per week. Therefore, if you are already stretching yourself with the monthly repayments of $1,976, an increase in interest rates could push you over the edge.
Fixed vs Variable Loans
There are three different types of loans you can get: Fixed, variable or split.
Fixed loans allow you to set a fixed interest rate for a set period of time. This means for a certain period of years you will have the exact same repayments. You may choose this option if you want certainty and don’t want any fluctuation in your repayments. The downside of fixed loans is that you are locked into that rate for that set period of time. If you were to refinance you would have to pay break fees, or if the interest rates drop, you will still be paying your higher interest rates. Fixed loans also generally wont let you pay any extra repayments, or may have a limit of an extra $10,000 a year for example.
Variable loans will have a varying interest rate, which rises and falls with the market, but is entirely controlled by the bank you are with. Variable loans offer great flexibility, and have shown to actually cost people less in the long run. The downside of variable loans is that they can rise and you can end up paying more, which if you haven’t budgeted for could put you under more financial stress. Another positive of variable loans is that you can often have a redraw or offset account attached to your loan. This means you can pay off your loan quicker if you want or have money offsetting the interest you are paying. I will explain these types of accounts more in the next section.
The last type of loan is a split loan. A split loan is where you can split your mortgage into a fixed and a variable part, so you get the best of both worlds. The fixed portion gives you security and certainty, while the variable portion of the loan allows you more flexibility and to allow you to make extra repayments off the loan.
A redraw account allows you to make extra repayments onto your home loan, thus decreasing the interest. Then, if you ever need that money for renovations or anything else, you can “redraw” it. It is important to note with redraw accounts, that once you have paid the money into the loan, it is technically the banks money. Some banks refused to give cash back from peoples redraw accounts in the height of COVID-19, something many people didn’t realise banks could do. This is obviously an extreme situation, and more often than not this money can be withdrawn whenever, however it is something to consider.
An offset account is an account that you can have tied to your loan, and any money in there will offset the interest you pay. For example, if you had a $500,000 loan and had $100,000 in an offset account against that loan, you would only be paying interest on $400,000 of the loan. Offset accounts generally come with additional fees, so it is important to see if the interest you’ll save is higher than these fees. How to do this is below:
$500k loan with 3% interest = 15k in interest p.a.
$20k in account, offsetting 3% interest = $600 saved p.a.
Therefore, as long as you have at least 20k in your offset account, and the fees are less than $600, you would be better off having an offset account.
For another example, lets say fees are $300 p.a. and you would only ever have $5,000 in your offset account each year, 3% of $5k is only $150, so you would actually be losing $150 a year to have an offset account and it may be better to go with a cheaper redraw option instead.
Other Tips & Tricks
- Pay fortnightly instead of monthly. There are 26 fortnights in a year, and 12 months in a year. By paying fortnightly, you will be making one extra repayment a year without even realising it, and saving you money in the long run.
- Just because the bank will lend you a certain amount, doesn’t mean you should automatically get a loan that size.
- When you are working out what you can afford, make sure to take into account your current lifestyle expenses, as well as rates, maintenance and other costs associated with owning a home.
- See a mortgage broker. They are free to go and see, they have great expertise and will be able to help you through the process. Couldn’t recommend this enough.