If you find yourself with less than the standard 20% deposit requirement to buy your first home, and are also struggling to figure out how/why things are different in this space when it comes to the banks - you're not alone!
In the current market, let's face it, it can be difficult to get access to 20% of the value of your desired property in cash, or even gifts (if you're lucky enough to be in a position to get this). More and more I find I am speaking to clients with less than 20% deposit, and what I seem to be finding is that clients aren't aware of how the banking market differs for clients in this situation.
When you have less than the standard 20% deposit requirement, banks need to lend more than 80% of the purchase price to make the deal work, otherwise known as "above 80% lending" or "low-equity" loans. In doing so, the bank takes on a higher risk with a borrower due to them having less capital in the deal, and the bank having an even larger proportion of their money in the deal.
As finance rates are priced on risk, the bank views the lending application slightly differently in a few different ways:
1. Assessment Criteria:
Banks are typically in the business of being conservative, and for this result when the deal is deemed to be more of a risk, banks require stronger applications and won't be as willing to negotiate on certain things. From a high level perspective, banks work out your total net income (currently) and subtract your current expenditure/commitments, and that net monthly surplus is used to determine your "Uncommitted Monthly Income". This figure is what they would use to assess your 'affordability' or 'serviceability' for a proposed loan. Banks expect typically that for above 80% loans, this figure should be higher before they are comfortable with lending, than if it were an 80% (or below) loan. In addition, they are less likely to want to include 'proposed' boarder income for someone who will be coming to live with you in the new dwelling, (or at least to the same extent that they will for an 80% or below loan) for example.
Banks also assess lending ability (affordability) in a way that is drastically different to how you look at things. It would pay to be aware of this when trying to figure why the bank wouldn't give you as much as you think you could afford.
Banks typically would give out the best possible rates (what you're seeing advertised in the media and on TV at the moment) to loans with 80% or less of a loan-to-value ratio (LVR). In addition to this they are giving 'cash contributions' which are a gesture of goodwill and basically a gift from the bank (assuming you stay with them for a reasonable period of time - 2-4 years depending on the bank) for your business. With higher LVR lending this isn't always the case.
This means that if you are in a position where you have less than 20% deposit, you are likely to not achieve the same rates as this and potentially pay slightly more in one of three major ways:
Low Equity Fees: if a bank is willing to give you their best pricing, they are often also charging a low-equity fee, somewhere between 0.25% - 0.75% (bank and LVR dependent) of the loan amount as a fee - up front.
Low Equity Margins: sometimes instead of charging a low equity fee the bank would be in a position where they actually end up adding a margin between 0.25%-0.75% on top of their pricing (sometimes higher depending again on bank and LVR). This can definitely add-up over the life of a loan, so in this example we encourage clients to try to purchase under-value and perhaps fix or float for 6 months. During this timeframe we could look at some minor cosmetic renovations, so that the new registered valuation in 6 months time is high enough to make the current loan equal to or less than 80% LVR. This would allow you to have access in a short space of time, to the best possible rates.
For the above - note that typically 80.01% - 85% LVR is 0.25% and 85.01% - 90% LVR is 0.75%.
Cash Contributions: If a bank would give you a cash contribution in this space, it is likely to be smaller than a standard cash contribution.
3. Other housekeeping:
Banks typically require valuations at this level, so it makes sense to allow for this within your particular property hunt, and financing/due diligence timeframes.
If you're struggling with having less than 20% deposit, and are trying to navigate this banking landscape along without any success - please feel free to make contact as I'd love to help!