Home loan deposit: Everything you need to know

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Home loan deposit: Everything you need to know

July 27, 2023

Home loan deposit: Why do you need one, how much do you need and how to save

Unless you're a millionaire and can purchase a home using cash you already have, you'll need a home loan deposit to buy a house.

While there are some daunting figures in and around home loan deposits, knowledge is definitely power - or stronger confidence at least!

Read on to find out more.

Why do I need a deposit?

Your deposit is a financial safety net for your lender and the larger it is, the less of a risk you are to them.

A large deposit also means you're less of a financial risk to yourself, as you own a larger portion of your home and your debt, or loan, is much less.

This is especially important if your life goes south overnight, such as losing your job or discovering you or a loved one has a major health issue.

How much do I need for a deposit?

Aim for a deposit equalling 20% of the value of your ideal property, as otherwise, you will need to pay Lender's Mortgage Insurance (LMI) - more on this acronym shortly.

You'll also be able to pay off the loan faster and therefore, pay less interest over the life of your loan.

As well, you need to consider your Loan to Value Ratio (LVR), which needs to be 80% or more to avoid paying LMI.

Your LVR is your home loan figure divided by the actual value of the property you intend to buy.

For example, if you're borrowing $300,000 for a property worth $350,000 ($300,000 ÷ $350,000), you're LVR is 85%.

What if I don’t have a 20% deposit?

This is a massive question and with house prices skyrocketing in recent years, and interest rates now on the rise, a very relevant one.

But there are ways to purchase a home with a low deposit, particularly for first-home buyers (FHBs).

The recently elected federal government introduced several more first-home buyer grants which allow this group - as well as single parents with children or other dependants who have previously owned a home - to buy a property with a 2% deposit.

Other FHB grants ask for only a 5% deposit while state-funded FHB schemes often allow this group to buy a house without paying stamp duty.

Non-FHBs may be eligible for similarly low deposit loans or can often use the equity in their first home to help them with a deposit.

Another option is asking a friend or family member to be your guarantor for a home loan.

But bottom line: low deposits often come with extra lender criteria and costs, with LMIs being just one of these.

And most importantly, lenders don't like tiny deposits.

So, if achieving that 20% deposit means working and saving harder for longer, then do so.

What is Lender's Mortgage Insurance (LMI)?

LMIs are an insurance policy for lenders and is required for anyone with a home loan deposit under 20%.

While low deposit-ers may be A-OK to pay off their home loan, LMI protects lenders wary of their ability to do so.

Depending on your lender and the loan, the LMI figure is paid upfront or is part of your overall loan, to be paid off over time.

The figure also varies depending on your deposit, your loan size and other factors.

And watch out!

LMI figures can add up fast, particularly for those with small deposits - and don't forget you'll need to factor in a longer loan and extra years paying off interest rates.

Using our online calculator we explored two home loans with identical interest rates and property values.

The 5% low deposit-er paid an extra $15,000 in upfront LMI premiums alone and over the life of the loan, $108,000 more than that of the borrower with a 20% deposit.

Saving for a deposit: where to start

Firstly, expect your deposit-saving road to be a tough one, and not just because of property price rises and interest rate hikes.

But if it's any consolation, our parents and grandparents found it just as hard to save - and that was at a time when most households were single-income ones and inflation was higher than it is now.

Here's where to start, however:

1. Think like a lender

... or like anyone who comes to you asking for the most massive favour of their lives, financial or otherwise. In essence, would you lend an extremely large amount of cash to someone like yourself? Are you financially reliable and trustworthy with your cash? Have you been saving for just a few months or for years? Where and how do you spend your cash?

2. How much do you need to buy a home?

Even before you think about LMIs and LVRs, find out exactly how much cash you'll need to buy your dream home.

Don't forget often forgotten, initial costs such as lender fees and charges, stamp duty, conveyancing, building and pest inspections, and home and contents insurance plus possibly paying LMI.

3. How much can you afford to spend on a home?

Answer this question realistically and consider it both in the short and long-term.

Again, don't forget costs such as council rates, utility bills, general maintenance including emergency repairs, and possibly, body corp fees.

4. Analyse your budget

Thoroughly explore and investigate your budget and your readily available cash.

What do you have in net savings, including investments?

How and where can you cut back on your spending?

Tips on saving for a deposit

Cut up your credit cards - or at least pay them off and lower your credit limit. While you're at it, pay off other debts including personal loans.
Have a goal and create a savings plan - you now know how much you need to buy a home. So set up a deposit goal via a realistic savings plan. This can be as simple as setting up an automatic transfer to your savings account when you receive your weekly paycheck.
Cut back on luxuries - this is one for the serious overspenders! But now that you've analysed your budget down to the last coin, you should be able to identify where and how to cut back. We're not saying delete every luxury from your life but what's more important to you? That gorgeous pair of heels or a home that's (mostly) all yours?