Banks need a buffer to safeguard their investments when they lend money to home buyers. That buffer is your home deposit. As a general rule, banks like borrowers to have a deposit worth 20% of the price of the property.
This then means your Loan to Value Ratio (LVR) is 80%. If the bank lends you 80% of the value, the bank feels comfortable that it can get its money back if you were to default on your loan and it was forced to sell the property.
Say you wanted to buy a property worth $500,000, you’d need to come up with a $100,000 deposit and borrow $400,000 to have an 80% LVR.
What some people don’t realise is that if your cash deposit, or useable equity, is worth more than 20%- say your LVR is 50 or 60%- the bank will potentially offer you a better interest rate or features than other borrowers.
The investor advantage
Property investors are charged higher interest rates on investment loans than owner-occupiers are. That’s designed to stop investors dominating affordable home markets at the expense of first home buyers.
But investors can often make up some of the difference through their LVRs, especially if they already have a portfolio. The advantage they have is that they may have accumulated equity that they can use as a deposit for subsequent purchases, while a first home buyer needs to save a cash deposit.
The better your LVR is in the eyes of the bank, the more bargaining power you have, because you are someone the banks will want to partner with to improve their risk profile and safeguard their wealth.
Once upon a time, if you had enough money saved and income flowing in, you could keep borrowing more and more properties. But post-GFC regulatory pressure means banks must be responsible lenders and restrict their exposure to investors. If you want them to fund multiple properties, you will need to help them out by being as agile and unencumbered as possible.
Less than 20% deposit
If you are unable to raise a 20% deposit, it’s not necessarily the end of the world. You still have options and can get a loan, but a bank may require you to pay for lenders mortgage insurance (LMI).
Generally speaking, LMI can range between $5000 and $20,000 depending on your LVR (is it 85%, 90%, 95%?), plus where the property is located and a range of other factors. How LMI is calculated exactly is a closely guarded secret by financial institutions, so it’s hard to predict with accuracy.
Importantly, it’s insurance that you pay, but that covers lenders. It protects the bank, but not you, if you were to default.
The good news is that it can be rolled into your mortgage repayments, so isn’t yet another upfront fee or tax to deal with. Sometimes, if property values are rising in your chosen market, it can be better to buy a property with a 90% LVR (if a bank is happy to lend) and pay the LMI, because you can access value growth that may actually pay for the LMI and then some in the first year or two of ownership.
If you choose instead to spend another year saving money (in a still low interest rate environment), the prices may climb out of your reach again by the time you have a 20% deposit.
Benefit from bank competition
Look out for various deals for first home buyers or investors from different lenders. The borrowing environment may be tough at the moment with rising rates and falling borrowing power, but there are also more lender options out there than ever before and they are all locked in a battle to win your business.
A special deal on LMI or a cashback offer might just boost your financial situation enough that an owner occupier or investment purchase becomes viable when it may not otherwise have been.
Couple that with some of the government incentives in place for certain homebuyers and you may grab a deal that gives you access to extra future wealth.
