When you're buying a house or an investment property, should you use a small or a big
deposit?
There are benefits and disadvantages to both, and that's what we/re going to be covering
in today's episode.
Hi I'm Ryan from onproperty.com.au, your daily dose of property education and inspiration.
If you want access to my free report where I show you 10 Real Positive Cash Flow Properties
in Australia, real on the market, you can check that out by going to onproperty.com.au/free.
Ok so small and big deposits; there are benefits and disadvantages to both.
There are a lot of people who stand in the camp of "you should always use a big deposit,
you should always use 20% and that way you can avoid Lenders Mortgage Insurance which
is a waste of money, and you should grow your portfolio that way."
And other people are standing on the other side of the fence, and they say you should
always use the smallest deposit possible, maybe that's 5, maybe that's 10% depending
on your loan, because the smaller the deposit that you use, even though you have to pay
Lenders Mortgage Insurance, it allows you to build your portfolio faster and therefore
make more money in the long run even though you had to pay lenders mortgage insurance.
So let's have a look at these two different options, because obviously, depending on who
you are, depending on what circumstance you're in, what your financial goals are, what your
investment plan is, your decision to whether to use a big deposit is going to be different
from my decision, it's going to be different than John's decision down the road and Jane
up the street.
Everyone's going to have a different decision on this matter.
The more we learn about it the better decisions we can make.
So let's start by looking at big deposits.
What are the advantages of using a larger deposit?
Well the major advantage of using a larger deposit, is that you can avoid what's called
Lender's Mortgage Insurance which is also known as LMI.
Lender's Mortgage Insurance is a fee charged to you by the banks in order to cover the
risk that they're taking if your deposit is less than 20%.
If you get a loan, you know you borrowing 80% from the bank and if you default on that
loan and you can't pay it and the bank needs to sell your house, they're pretty confident
that they can get their 80% back.
If, however, you only have a 5% deposit or something like that, the banks aren't as confident
that they can get 95% of their value back from selling the house as they would be to
only need to get 80% back; so there's increased risk for them and that's why they charge this
insurance premium to you if you don't have a large deposit.
So having a large deposit, you can help avoid that and it's generally thousands of dollars.
Another benefit of a large deposit is sometimes it can help you access easier financing.
Certain areas like country towns often require at least a 20% deposit because less lenders
would go into that area, but certain loans and depending on your circumstances, you may
be able to find easier financing if you have at least a 20% deposit.
If you only have a 5% deposit or a 10% deposit, you might find it more difficult; and from
previous research that I've done, if you're building a new property and you need to get
a construction loan, then generally a 5% deposit isn't going to be an option for you.
If you want to get financing, you're really going to need to have probably around that
10% mark.
There is the possibility that you could access a better deal or better interest rates on
your loan with a larger deposit.
Now this may be 20% or it may be offering as much as 30 or 40% or more on a property.
If the banks are taking less risks, well obviously they might be willing to cut down the interest
rate, they might be willing to do a better deal with you; but you really need to speak
to your lender, or you need to speak to a mortgage broker because lending changes all
the time, so I can't say 'well this banks' going to do it and this one doesn't' because
that's not really going to be helpful to you by the time you've watched this.
So, if you want to get in touch with my mortgage broker, or you want him to get in contact
with you because you don't have one, go to onproperty.com.au/mortgage, enter your name
and phone number and he'll give you a call and you can discuss that situation with him.
Another benefit of having a larger deposit is your ability to access equity faster without
paying Lenders Mortgage Insurance.
So let's say, let's use a really rough example and this isn't to be considered financial
advice, it's just a rough example.
Let's say that you're buying a property worth $500,000.00 and you're putting down 20% deposit
which is $100,000.00, you then have a full $100,000.00 loan on that property.
Effectively at time of purchase, you have $100,000.00 in equity in that property which
is remaining value.
As that property goes up in value, your equity goes up in value and your what they call "loan
to value ratio" goes down.
So when you have $100,000.00 of equity in the property and $400,000.00 of loan, well
that means you've got an 80% loan to value ratio; but, if that property goes up in value,
and let's say it goes up to $600,000.00 or $700,000.00 you then got $300,000.00 in equity
versus $400,000.00 in loan on that property.
So as you can see the ratio is very different.
What this means and why it kind of'can be better than a 95% loan or a 90% loan, is that
any extra equity you gain from an increase in value on your home, brings your loan to
value ratio below 80% and now with most lenders, if you go and get an equity loan, as long
as you don't go over the 80% loan to value ratio, you can get an equity loan without
paying Lenders Mortgage Insurance, however, if you use a smaller deposit, let's say 95%,
as the value of your property goes up, well your loan to value ratio might drop to 90%,
then it might drop to 85% then it might drop to 80%; but even if its dropped to 80%, if
you want to get an equity loan, you're going to have to bump your ratio up to 90% or 95%
in order to access that money and then they're going to charge you Lenders Mortgage Insurance
again to access that equity loan.
So you kind of if you're getting a 95% loan, it's going to get down to the 80% loan to
value ratio, then it's going to get even lower than that but your property will continue
going up in value in order for you to be able to access equity without having to pay Lenders
Mortgage Insurance again.
So that is a difficult topic to explain in a video but I hope that that came across and
you understood it.
Some of the negatives of using a larger deposit are that obviously, it takes a lot longer
to save.
On a $500,000.00 house, a 5% deposit is going to be $25,000.00; a 20% deposit is $100,000.00.
Now I don't know about you and what your financial situation is, but the difference for me to
try and save $25,000.00 versus me trying to save $100,000.00, they are worlds apart.
So by opting for a lower percentage, it means that you can save it quicker.
Obviously a larger deposit means it's going to take you longer to save it, and it also
means another disadvantage of having a larger deposit is more time out of the market.
Because if you're spending time saving money in order to get a large enough deposit to
have that 20%, well that's time that you're not in the market and potentially taking advantage
of market growth and capitalization of your property.
So yes you're saving, yes you're avoiding Lenders Mortgage Insurance, but you're also
out of the market while you're trying to save it and as we know, properties tend to continually
grow.
So if you're out of the market you could be missing out on that sort of growth.
All right now let's look at the smaller deposits, your 5%, your 10% and that sort of stuff.
The benefit of the smaller deposit is obviously that you can get into the property market
faster.
You don't need to save as much money in order to get in which means you don't need to take
as long to save.
Being in the market earlier means you have the potential to get growth sooner.
That could be growth through the market just naturally going up as it tends to do, you
know over the years, or, it could be you actually having a property that you own and you being
an active investor and doing things to increase the value of that property.
So that could be you could be doing a renovation, or you could be doing a sub-division, or adding
a dual occupancy or building a (00:09:09).
You could be doing all these different things to add value to your property, and these sorts
of things you couldn't do when you were just saving a deposit or you didn't own anything.
So you can either get the natural growth if that's happening in the area, or you can potentially
manufacture growth which then speeds up how much money you're making and then speeds up
how quickly you can grow your portfolio.
The downsides to having a small deposit is that you need to pay that Lenders Mortgage
Insurance which we talked about which is thousands and thousands of dollars, and also (00:09:40)
you can get that added to the loan.
So it doesn't have to come out of your own pocket, and that means, you know, you don't
have to come up with the cash for that insurance, but it is added to your loan; so therefore,
your interest repayments are going to be slightly higher and its going to take you longer to
pay it off than otherwise.
You may have trouble with lending depending on your financial situation, what your borrowing
capacity is.
There are so many different factors that go into this.
By only having a 5% or only having a 10% deposit may restrict what lenders you can go with,
and may rule out some of the lenders that would have (00:10:15) you favorably if you
had 20% deposit.
So by having less, you're probably ruling out some lenders which may make it harder
to access financing, but again, go and visit your mortgage broker about that one and ask
for them.
A lower deposit may incur a higher interest rate with some lenders.
Again, check with your mortgage broker on that one, and you may need your property to
grow much more to access equity with avoiding the Lenders Mortgage Insurance.
So just like we talked about the benefits of having a larger deposit is as your property
grows, you can actually access a lot of that equity, whereas with a smaller deposit, as
the property grows, first you have to exceed that or come below that 80% loan to value
ratio before you can really access any of that equity without paying Lenders Mortgage
Insurance.
So there's some benefits and there's some cons to both; having a larger deposit and
having a smaller deposit.
What you want to do and what your decision is going to be is really up to you, and I
don't know your financial position, I don't know your investment goals or your experience,
so please don't take any of this as financial advice, just for educational purposes only,
but I hope looking at these benefits and negatives have helped you get some clarity, and helped
you to make your decision.
And I wish you all the best in your investment journey.
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