Buyers urged to consider 'riskier' mortgage costs before bounding into booming market

Whichever way you slice it, the Australian property market has been booming. 

Home value growth recently hit a 17-year annual high, while lending figures from the Australian Bureau of Statistics continue to show the high demand for new home loans - borrowers took out $32.1 billion worth of loans in June alone. 

And despite a recent drop off, first home buyers are still entering the market in numbers not seen in over a decade. 

Given the skyrocketing prices, it’s understandable that many new or first-time buyers will have been struck by the idea of FOMO (fear of missing out). But would-be buyers looking to get into the market faster have been urged to make sure they’re aware of the extra costs that may be involved with ‘riskier’ mortgage options.  

“If you’re trying to break into the booming home loan market with a small deposit, family guarantee or longer loan term, it’s important to know what you’re getting into and understand the risk you’re taking,” says Mozo spokesperson, Tom Godfrey.

So with that in mind, we’ve crunched some of the potential costs involved when opting for a ‘riskier’ mortgage. 

Purchasing sooner with a lower deposit

In the industry a ‘standard’ deposit is considered to be 20% of a property’s value, but plenty of lenders allow borrowers to take out home loans with deposits as low as 5%. And while it may be tempting to purchase a property faster with a smaller deposit, lower deposit home loans aren’t without their additional costs. 

One of these can come in the form of higher interest rates that lenders typically charge borrowers on mortgages with higher loan-to-value ratios (ie. those with lower deposits). 

For example, comparing the average variable rates in the Mozo database at different LVR tiers revealed that on a $400,000 loan, an owner occupier borrower with an LVR of 95% would pay $1,807 in monthly repayments compared to $1,725/month with an 80% LVR. 

Aside from rate premiums, one almost inescapable cost for home buyers with a deposit under 20% is lenders mortgage insurance (LMI). 

And LMI isn’t cheap. Typically it will be an additional cost in the thousands or tens of thousands of dollars that borrowers will be required to pay, although buyers eligible for the First Home Loan Deposit Scheme (FHLDS) will be able to avoid it. 

“While it might be tempting to leap on to the housing ladder with a small deposit while the market is booming, it’s important to understand the additional costs such as LMI,” says Godfrey.

“LMI was introduced in Australia in 1965 to help lenders work with borrowers who have smaller deposits. The smaller deposit you have the more risk the lender takes on so they charge you a one-off fee which helps cover their costs if you were to default on your loan.” 

Stretching out your home loan 

Typically, home loans tend to be taken out over 25 or 30 years. So while there’s nothing unusual about a 30-year home loan term, stretching out a home loan over a longer term is likely to end up costing borrowers more.  

For example, a mortgage holder with a $400,000 loan and a variable rate of 3.24% would pay $41,761 less interest if they paid their loan off over 25 years rather than 30 years.

“Extending your loan by five years or pulling back on paying down the principal loan amount might give you short term respite from bigger monthly repayments but long term it can be a financial trap,” says Godfrey.

On the subject of time, Godfrey also highlights the need for borrowers to prepare for the possibility of rate rises over the period of the loan term, saying: “It’s important to stress test your ability to make repayments on a bigger loan amount to prepare for future interest rate increases.”

Currently home loan rates are at the lowest levels they’ve been in years, but there’s no guarantee that they remain this low. In fact, ANZ, CBA and Westpac have all forecasted that the Reserve Bank will begin to lift rates in the next few years. 

Getting family to guarantee your loan

While the Bank of Mum and Dad continues to be one of the nation's largest mortgage lenders and one of the only ways for many Australians to be able to purchase property, getting a family member to go guarantor on a home loan isn’t without its risks - and they’re not just financial. 

According to ASIC’s Moneysmart, guarantors should be aware that their own home could be at risk if the loan is defaulted on, it could affect their credit report and, if things go sour, it could damage family relationships.  

Ultimately, whether it’s borrowing with a lower deposit or getting a family member to guarantee a loan, Godfrey urges prospective buyers to take the time to weigh up the costs and risks involved with taking out a mortgage. 

“Despite the economic uncertainty, it’s clear Australians' love affair with property is continuing. But it’s important to remember, taking out a home loan should be a financial decision, not an emotional one.” 

“If you’re trying to enter the property market your best option is always to save a decent deposit, buy a property you can afford and get the best home loan rate possible.”

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