When buying a home, the banks generally want you to pay 20% of the property value as a deposit. This can obviously be a lot of money – let’s look at why banks ask for it and how you can reduce it.
Why do banks want a 20% deposit?
From a Banks point of view, they take a risk every time they lend you money. What they need to think about is what would happen if you could no longer afford to repay the loan because something happened to you. The bank would initially try to give you time to try and catch up on your payments but if you couldn’t, the bank needs you to sell your house to repay the loan. By paying a sufficient deposit, the banks are also confident that you have enough ‘skin in the game’ and know what you are doing.
Now lets suppose you bought the house for $500,000 and the bank said you don’t need to pay a deposit and lent you the full $500,000. When you can’t repay anymore, the bank needs to sell your house quickly – if the value of your property has dropped, the bank will lose money. Even if it hasn’t dropped, the bank may need to pay a real estate agent to sell the house and will lose money as a result. A 3% agent commission on a $500,000 property is about $15,000 !!
To reduce their risk, the bank asks you to pay a 20% deposit so that in the $500,000 example – even if your property went down $100,000 in value – the bank would not lose any money.
The bank is completely justified in doing this because they are not investing in the property but rather you as a borrower. The bank also only charges interest on the loan and does not share any property gains that you may receive. It is important then for them to manage their risk appropriately.
Options to pay less than 20% deposit
The bank does give you some options to get away with paying less than the 20% deposit but only if you can help them reduce their risk. Let’s look at these options:
Option 1: Lenders mortgage insurance (LMI)
Some banks will ask you to pay only a 5% deposit if you take out Lenders Mortgage Insurance (LMI). LMI is a type of insurance where an insurance company gives the bank a guarantee that if you were in a position where you couldn’t pay your loan anymore, they would compensate the bank for any loss the bank makes.
The big drawback of LMI is that it’s very expensive – if you only had a 5% deposit and were buying a $500,000 property – then your LMI premium would be about $15,000-$16000. The slightly good news with LMI is that banks let you add it to your loan amount – also known as capitalisation. This means that you don’t have to pay the full LMI premium upfront but can rather add it to your loan amount.
What does this all mean? – you could buy a $500,000 house with only about $30,000 saved up if you don’t have to pay stamp duty but the house ends up costing you an extra $15-$16,000
Option 2: Find a guarantor
Most banks offer a family guarantee option to help reduce the deposit you pay. This option however requires someone else (usually your parents) to take a risk for you. The way it works is that your parents agree with the bank that if the banks lend you the money, they will guarantee that you will pay the money back. If you don’t, then the bank can sell your property and even your parents’ property to recover their money.
For this option, you need parents that own a house and are willing to take the risk for you. Some banks will lend you the full loan amount of the property you want to buy so that you don’t even need to pay a deposit.
What does this mean? – you could buy a $500,000 house with only about $5000 saved up if you don’t have to pay stamp duty but you would be putting your parents house at risk.
Option 3: Work in the Medico sector or work for a bank
Another policy most banks have is that they only ask for a 10% deposit if you work either for the bank or in the medical sector which means you are employed as a Doctor, nurse or pharmacist but can include other health workers. The reason they do this is because historically the health industry has stable employment rates and people are generally less likely to lose their jobs. The banks have experience and also have data that proves that these types of customers are less risky.
What does this mean? – you could buy a $500,000 house with only about $55,000 saved up if you don’t have to pay stamp duty and you wouldn’t be paying any extra or putting anyone else at risk
Option 4: Look for campaigns
Some banks have recently started running campaigns where you don’t have to pay LMI if you have a 15% deposit instead of 20%. This generally means that you could buy a $500,000 house with about $80,000 saved up if you don’t have to pay stamp duty.
Option 5: Cross collateralisation
This option is only available to people that already have an existing house. You would need to offer the bank both houses (the one you are buying and the one you already own) as security to lend you the money with no deposit. The bank can sell both houses if you can’t pay back your loan. See my blog on what is equity and how do I access it to see how this works.
To sum it all up, the banks want you to have ‘skin in the game’ when buying a property to show you know what you are doing and help reduce their risk. They provide options to lower the deposit you need provided it manages their risk. These options are a result of innovation and experience within the banking sector.