Are 5 per cent deposits the answer to first-home buyer woes?


It's now so difficult to buy a home in Sydney that first-home buyers are buying in with as little as 5 per cent deposits - and developers are on board assisting those with meagre savings. But is the strategy worthwhile?

One couple - Joe and Daissy??? Del Rio - certainly think so. They signed a contract to buy a one-bedroom apartment in February in Mirvac's Pavilions development with a 5 per cent deposit.

The engineer and nurse were stuck on the rental treadmill with their two-year-old son and decided it was time to settle down somewhere close to decent schools. An initiative from Mirvac to set aside some new apartments at their Olympic Park development for first-home buyers with smaller deposits was enticing for them.

But even then the couple had to sacrifice to get the money together for a one-bedder, which were priced up to $650,000 equating to a 5 per cent deposit as high as $32,500.

"We had two cars so I sold one - with that money we had a complete deposit," Mr Del Rio said.

By late-2020 to early-2021 they expect to move into their new home. After selling out of one-bedders at the latest release stage on Saturday, there are now 68 first-home buyers who have taken up the offer.

"We suspect we'll stay there for at least a year - going to use it as leverage for buying a house if we can have more kids or pets. Just a start," Mr Del Rio said.

If this hadn't been an option "we would've waited probably five years to actually have the money to get into a townhouse," he said. And that's assuming prices don't change from 2017 levels.

The developer-offer allows first-home buyers to lock-in their home with a 5 per cent deposit, but also requires two annual payments of 2.5 per cent to push the deposit up to 10 per cent by settlement, Mirvac's general manager of residential development NSW Toby Long said.

"We all know affordability is an issue for first-home buyers in Sydney and we looked at what the difficulties are for people to get into the market," he said.

He said buyers were required to speak to a mortgage provider ahead of time to ensure they wouldn't be too stretched to get the loan.???

The risks of a small deposit

Fintech lender Tic:Toc Home Loans chief executive Anthony Baum said a 5 per cent deposit was a good option for those with a stable income, who can pay down the loan quickly and know they can meet repayments easily.

"These customers should select a principal and interest product and try and make voluntary or higher than minimum repayments to pay down the loan as fast as possible and build their home equity base," he said.

But when the market doesn't increase in value - the risks become obvious.

Mr Baum warned those who borrow more will have a larger amount of debt, leaving them in a potentially difficult situation if their circumstances changed.

If property values fell and they needed to sell, this could leave them owing more than what their property is worth after selling costs and the value of the home are taken into account.

How the numbers stack up

In a fast-growing market buying with a small deposit can provide a way to benefit from rising prices quickly.

Someone who bought a median priced house at the beginning of 2012, at about $650,000 with a 5 per cent deposit of $32,500, would have seen prices jump to $1.18 million by mid-2017.

A loan taken out in 2012 for $617,500 - a 95 per cent loan - paid back over 25 years, would cost an additional $464,581 in interest with $832 weekly repayments. Assuming a 5 per cent interest rate.

Delaying five years to save more would leave them needing a $59,000 deposit to reach 5 per cent of a $1.18 million median - or $236,000 to make a 20 per cent deposit. And they would've missed out on more than $600,000 in capital growth.

But in a slower-moving market, buying in with a 5 per cent deposit is not as financially beneficial.

With a $1.18 million median - providing the market doesn't move from 2017 onwards - having a 20 per cent deposit, compared to a 5 per cent, could reduce repayments by $240 a week and bring the interest down $130,000 over the life of the loan.

And buying with just 5 per cent in savings in any situation can mean facing higher interest rates and having fewer lending products to choose from, Smartline mortgage broker Sam Ghoreyshi said.

Even saving to 10 per cent would widen options for buyers and dramatically reduce lender's mortgage insurance (LMI) - a cost charged to borrowers that insures the lender when a loan is more than 80 per cent.

This cost could add again onto the loan - in addition to the calculations above.

For a $650,000 home, borrowing 95 per cent would cost $27,849 in LMI. If added onto your loan - or 'capitalised' - this would cost $140 a month at at a 5 per cent interest rate.

For the same home, borrowing 90 per cent would see $14,274 paid in LMI - an additional $71 a month if part of the mortgage.

But Ghoreyshi noted "to avoid the 5 per cent issue and if servicing is fine, first-home buyers can potentially use family guarantee loan option to avoid LMI".

Another alternative?

First Home Buyers Australia co-founder Taj Singh thought low-deposit options from developers were a good option, but said "they are only offering first home buyers a one-bedroom opportunity".

"Most other developers are happy to accept a 5 per cent deposit until settlement anyway, which doesn't really make Mirvac's offer any different - apart from the priority access they are granting to first-home buyers," he said.

Mr Singh said his preference would be for shared ownership schemes as a way to help first-home buyers.

A shared home ownership scheme currently exists in Western Australia, which allows qualifying applicants to buy a home with a 2 per cent deposit with the government owning a portion of the property.

This story Are 5 per cent deposits the answer to first-home buyer woes? first appeared on The Sydney Morning Herald.