Caution needed when buying a house with a small deposit….
A total of 20,000 places will be made available from July 1 in schemes operated by the federal government where first-home buyers and single parents need only a small deposit.
However, while qualifying first-home buyers can put down a deposit of 5 per cent and single parents just 2 per cent, there are traps that await the unwary.
Mortgage interest rates are at a record low but at some point variable mortgage rates will start rising. Four-year and five-year fixed-rate mortgage interest rates are already on the way up as lenders anticipate that official interest rates set by the Reserve Bank of Australia will be higher by then.
And though a rise in variable-rate mortgage interest rates could be as much as a couple of years away, once they do start to rise, they could rise quickly, substantially increasing repayments by those taking out a low-deposit mortgage at a bargain-basement rate of interest.
Calculations by Canstar show repayments of $2,690 a month on a $588,000 mortgage over 30 years, using a variable interest rate 3.65 per – the average on its database. The total interest paid is $380,350.
However, if after four years the mortgage interest rate increases by one percentage point to 4.65 per cent, the monthly repayment increases to $2,994 – just over $300 a month higher – and the interest paid would be $475,273.
Even though a one percentage point rise is relatively low by historical standards, is has a big impact on repayments. That is something anyone thinking of taking part in one of the government’s low-deposit schemes needs to keep in mind.
Of course, there are advantages of getting into the property market earlier with a smaller deposit. Price rises, though now beginning to slow, are likely to continue their upward march for some time.
A big plus of the low-deposit schemes is that the borrower does not have to pay for lenders’ mortgage insurance. Though the insurance reimburses a lender for any shortfall should a property be repossessed and sold for less than its outstanding mortgage debt, it is paid for by the borrower.
Normally, a buyer needs a deposit of at least 20 per cent to avoid having to fork out for lenders’ mortgage insurance.
Under the low-deposit schemes, the government becomes guarantor for borrowers, so the first-home or single-parent buyer does not have to pay for the insurance.
The other issue for anyone buying with a small deposit is the potential of “negative equity”, where the money owed on the house is more than it is worth, should property prices fall significantly.
Buyers do not give it much thought when prices are rising, but property prices do indeed fall.
For someone who is putting down a deposit of only 2 per cent, or even 5 per cent, that does not leave a lot of room for prices to fall before hitting negative equity.