Five things to consider when borrowing money to buy a home
There’s a lot to consider when buying a home, especially regarding finances.
There’s a lot to consider when buying a home, especially regarding finances. From your initial deposit to insurances and your repayments, we’ve highlighted some of the most important factors for you.
How much you should put down as your deposit depends on a number of factors. In general terms, many lenders in Australia (including the Big 4) will provide up to 95 per cent of the purchase price, meaning you need to have saved five per cent. If you're looking to buy a home for $1,000,000, you'll need $50,000.
Getting accepted for a loan with a smaller deposit will require you to have a high income, stable employment, a good credit history and minimal debt. As a general rule, the more you can put down as a deposit the better off you'll be.
In New South Wales, the state government's First Home Owner Grant can provide $10,000 towards the purchase of a new build.
2. Mortgage insurance
There are two types of insurance you may have to factor into your costings: Lender's Mortgage Insurance and Home Loan Protection.
If your deposit for your loan is less than 20 per cent of the property's value, your lender is likely to charge you Lender's Mortgage Insurance (LMI) to cover them in case you can't make your repayments.
This fee will rise as the amount you borrow rises, simply because your lender has more to lose if you default on payments. Likewise, the smaller your deposit, the higher your LMI is likely to be.
While LMI is there to protect the lender, Home Loan Protection (HLP) is designed to help the home buyer. Home Loan Protection varies from lender to lender, but generally, it covers your payments (up to a certain limit) if you are unable to work. You may also be eligible for lump-sum payments if you are diagnosed with a major medical trauma, and it can also pay off the remainder of your loan, or a large chunk of it if you were to pass away.
3. Principal and interest-only loans
All home loans in Australia fall under two categories: principal and interest-only. The difference is how much you pay off – with principal loans, you make bigger repayments because you're paying back the loan while also paying the insurance. With interest-only loans, you pay the interest but don't make a dent in your actual mortgage.
With principal loans, you take out your mortgage over a fixed term. Your lender works out how much your payments will be (including the interest due), and you'll pay that amount for the duration of the loan. With each payment, you'll notice the amount you owe your lender starts to get smaller. At some point, if you keep up with repayments, you will own your property outright.
Interest-only loans, however, do not reduce the amount you owe. The payments you make are merely to cover the interest of your loan so, as you're not reducing your loan amount, this figure is unlikely to go down much. This type of loan is generally more suited for people making property investments (as it frees up their cash flow) rather than people buying somewhere to live in themselves.
4. Ongoing repayments
One of the main factors in choosing between principal and interest-only loans is working out your budget and what your quality of life will be afterwards.
Another finance term that comes into play here is 'serviceability'. This gives lenders an idea of how much you can afford to pay each month. If your loan demands that you pay back too high a percentage of your monthly earnings (through jobs, benefits and/or investments), it's unlikely that you'll be approved.
While serviceability is vital from a bank's perspective, it's something you should consider too. If your home repayments take up too much of your income, you'll find that you won't be able to enjoy the standard of life you expect and you may be better off renting for a while.
5. Parental guarantees
If you want to buy a home sooner rather than later but don't quite have the required capital, speaking to your parents and asking for support can speed up the process. By having one or both sign on as a guarantor of your home, you can potentially buy a property sooner and save money.
If your parents can help in this way, they don't have to have money available to invest. Instead, if they have equity in their home or investment property, they can provide a Parental Guarantee of a certain amount. This can lower the loan to value ratio, which determines if you have to pay Lenders Mortgage Insurance. Generally, the smaller your deposit the more you have to pay in insurance, so your parents' help can lower or remove this extra payment.
The main drawback to this option is that if you can't make your full monthly payments, your parents are liable to foot the bill. However, once you've started to pay back your debt and built up your equity, you can take your parents off your loan and remove their liability.
Buying a home is a huge decision and not one that should be rushed into. Be sure to think carefully about your finances and shop around for the best deal with banks and mortgage brokers.