Saving real money with a decent deposit

It feels great to be heading into the warmer months, and I'm sure real estate agents around the country will be gearing up for the spring selling season - typically the busiest part of their year.

Buyers could also be out in force encouraged by very low interest rates. But having a decent deposit can be the key money saver when you're buying bricks and mortar.

The amount you can borrow as a percentage of your home's value is known as the 'loan to valuation ratio' or LVR. An LVR of 80%, meaning you have a 20% deposit, tends to be the benchmark for buying property though you can take out a mortgage with far less.

Assuming you meet a lender's basic criteria like having a regular income that's sufficient for you to meet repayments, some lenders will happily provide loans for 90% - even 95%, of a property's value.

It means you could take out a loan for a home worth $500,000 with a down payment of as little as $25,000.

This may be a very tempting strategy especially as buying property also involves substantial upfront costs like stamp duty, pre-purchase inspections and legal fees, which all eat into personal savings.

However having the biggest possible deposit makes good financial sense. 

For starters, if you borrow 80% or more of a property's value, your lender will ask you to pay lenders mortgage insurance (LMI). This is a one-off cost organised by your lender, and it's a charge worth avoiding.

LMI protects the lender, not you - the borrower, if you cannot keep up the loan repayments. In the event of the lender repossessing your home and selling it, LMI covers the lender if the sale price is below the outstanding loan balance.

The greater worry is that LMI premiums can be extremely high. As a guide, buying that $500,000 property I mentioned earlier with a deposit of just $25,000 would result in an LMI premium of about $17,480.

It you don't have the cash on hand, you may be able to capitalise LMI, meaning it's added to the loan value and repaid over time. In the example noted above, this would mean paying back an extra $134 each month on top of your regular repayments.

That sort of extra payment is like a massive hike in interest rates. Yet plenty of home buyers wear this cost because they don't have a sizeable deposit.

There are other benefits to having a reasonable down payment. You won't need to borrow as much so your repayments will be lower and any future increases in interest rates will have less of an impact on your personal cash flow.

I appreciate that for first home buyers especially it can be challenging to save a decent deposit. Nevertheless if you can manage it, you'll be financially better off from day one.

For ideas on building savings check out my book Making Money. To discover what you could be up for in lenders mortgage insurance, search for it online where you'll find an LMI calculator.

Paul Clitheroe is a founding director of financial planning firm ipac, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.

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