Property prices set to rise: Should I buy now with a 5% deposit home loan?

With housing prices and rental yields on their way back up, many Australians are keen to snag a piece of the investment property market pie. In fact, 26% believe now is the best time to invest, according to recent ING research. 

But if you’ve been struggling to raise the standard 20% deposit, the big question for you may be whether it’s a good idea to climb the property ladder with as little as 5% saved up. Let’s take a look at the pros and cons.

Low deposit home loans: pros vs cons

Low deposit home loans are generally the most beneficial in a rising market where property prices are projected to keep increasing. That’s because they allow borrowers to get their foot into the door sooner while prices are still low. 

Right now, Australia’s property market is already showing signs of recovery from COVID-19. The latest SQM figures (for the week ending 3 November) show that house asking prices went up almost across the board since the previous week, with Melbourne being the only capital city to record a drop as it re-emerged from lockdowns. Compared to the last quarter and last year, house asking prices have also seen an upward trend in most capital cities:

Mozo’s property expert, Steve Jovcevski says that with rebounding prices likely to boost activity in the investor market, a low deposit loan could be an easy way to stay ahead of the flock.

“Investors are looking at historically low interest rates and they may also see value in the fact that [property prices] could be at their bottom and buying into the market could earn them a capital return in the next few months or couple of years,” he said. 

“Sometimes if the market is going up and you go ahead and still save a 20% deposit for the next couple of years, then you might actually lose out more than if you had jumped into the market earlier. You’d miss out on the opportunity to snag a cheaper property and benefit from capital growth.”

Jovcevski says that’s why doing research on location is so crucial. Talk to a buyer’s agent or real estate agent and make sure you’re buying into a rising market before signing on the dotted line. 

As for the downsides to a low deposit home loan, the major one is the cost involved. Previous Mozo data has shown that 5% deposit loans have average variable interest rates that are 82 basis points higher than 20% deposit loans. 

This 0.82% rate difference means that for a $700,000 home loan over 25 years, your monthly repayments could be $305 more expensive.* 

Plus, if your deposit is below 20%, you’ll typically need to factor in Lenders Mortgage Insurance (LMI). This is an additional charge paid to the lender because you’re borrowing a large portion of the property value and therefore considered a more risky customer.

How to reduce the risks of a low deposit loan

While those costs may be a deterrent for many people, co-founder of Freedom Property Investors, Scott Kuru says there are ways to counter them.

One is picking a cashflow positive investment property. 

“This means your rent covers your [potentially higher repayments and other property maintenance costs] with a bit left over as a buffer,” Kuru says.

“If you can get a rental guarantee as well, which guarantees you’ll receive a certain rental income, it’s even better.”

Take Wollongong, for instance, where rent is usually more affordable than in Sydney but properties are also much cheaper to purchase. That situation makes it possible for monthly repayments to be even lower than rent.

But the tradeoff with cashflow positive properties is that “they don’t go up as much in value”, said Jovcevski. 

Jovcevski says that alternatively, you could consider buying a property with someone else, like a sibling or partner. That way, you can split the cost of the deposit and monthly repayments. 

Meanwhile LMI can be dodged by getting a guarantor - someone who becomes responsible for repaying your loan if you aren’t able to. There are a couple of candidates to pick from, depending on your situation:

• Your parents or guardians can put their name next to yours on the home loan application. Just bear in mind that since their property will be secured against yours, it’s crucial to stay on top of your repayments.
• The government is your other option. Under its First Home Loan Deposit Scheme, the government is helping eligible first home buyers with a 5% deposit avoid LMI by guaranteeing the remaining deposit requirement of the home loan. Recently it’s added another 10,000 spots, although this version is only available for new homes or newly built homes. Also, because this scheme is only open to owner occupiers, if you eventually want to rent out your home, you’ll still need to temporarily live on the property (for, say, six months) to qualify for the guarantee.

The big banks may also waive LMI for certain professionals who are deemed lower risk because they have more secure jobs and higher income. For instance, ANZ’s LMI waiver for 10% deposits applies to doctors, lawyers, solicitors and chartered accountants.

The challenge of getting approved

Besides higher costs, customers with low deposits may also face stricter serviceability criteria. So to be approved, you must be in a strong financial position - in other words, have a full-time job, a good credit score, and a solid repayment history. 

Here are a few other steps to take to help boost your chances of getting approved:

• Have proof of genuine savings: When applying for a home loan, lenders expect part of your deposit to be funds you’ve saved up over time (accumulated over three months or more). For a 5% deposit loan, lenders may want to see at least 3% in genuine savings. Remember that things like cash gifts and inheritance money won’t count towards genuine savings, unless they’ve been held for a minimum of three months.
• Make repayments on time: Whether it's for your rent or credit card balance, being punctual with repayments is key to proving to the lender that you’re a reliable borrower. If you’re worried about being forgetful, simple things like putting a reminder on your phone or setting up automatic repayments can help.
• Get rid of bad debts: Managing multiple debts is always more challenging than having only one to focus on, so lenders tend to favour borrowers who are clear of other debts (like personal loans or credit cards). Bear in mind that even if you keep a card just for emergencies and don’t use it for everyday purchases, the lender will still factor in your credit limit as debt that you could potentially have. So before applying, it’s worth either lowering your limit or cancelling the card altogether.
• Secure rent: Kuru says having a rental guarantee could also be a big plus, as it gives the lender peace of mind that you’ll be able to afford your repayments (or part of it) with rental income.

Ready to start comparing home loans that accept deposits below 20%? Scroll down below to peek at a few offers, or head on over to our low deposit home loans comparison table for even more options.

*Calculations based on the rate difference between the 95% LVR (or 5% deposit) average of 3.74% and the 80% LVR (or 20% deposit) average of 2.92%. Averages as of 25 September 2020, assuming an owner occupier making principal and loan repayments on a $400k loan.