Strategies to combat rising interest rates
The Situation – ‘Hidden’ Home Buying Fees:
For many homebuyers, loans are required to help afford property purchases. Lenders who issue these loans require homebuyers to ‘put down’ a deposit on the property, to ensure the buyer owns a portion of the property, reducing the risk of default. Lenders will charge extra ‘Lenders Mortgage Insurance (LMI)’ fees when a deposit is below 20% of the property price, to account for the increased risk the lender is taking on.
Soaring house prices over 2021 have reduced housing affordability for many homebuyers, especially younger first-home buyers. Saving up a 20% deposit is difficult at current prices, causing many to purchase property with a low deposit, leading to a downward spiral as the lenders charge LMI fees, further increasing the cost of purchasing. For example, a 5% deposit on a $700,000 property in Pakenham will cost roughly $31,397 in upfront LMI fees.
The Solutions – Removing Lenders Mortgage Insurance:
- Home Loan Deposit Scheme
To support first-home buyers, the Federal Government operates the ‘First Home Loan Deposit Scheme’, which allows eligible buyers to purchase a property with a minimum 5% deposit, removing LMI fees usually charged at these deposit levels. Reducing the upfront cost of purchasing a home for young homebuyers is very important in the current ‘high cost of living’ environment. This scheme will apply to homes priced below $800,000 in the Metropolitan Melbourne area (different thresholds for other cities and regions). New places on this scheme are expected to be released on July 1, 2022.
- Help To Buy Scheme:
The Government contributes up to 30% of the deposit for existing home purchases, becoming a part-owner in your house. This scheme which is not limited to first home buyers, will remove costly LMI fees and enable borrowers to purchase a home with a minimum 2% deposit. Due to the Government owning a part of the property, the monthly repayments under this scheme will be lower than compared to if a first-home buyer was to utilise the ‘First Home Loan Deposit Scheme’, however individuals must earn below $90,000 per year while couples must earn below $120,000. If your income exceeds the threshold, you will be required to begin repaying the Government after a 3 year buffer. Changes in the market value of the property will also be split proportionally with the Government. If you sell for above your purchase price, the government will keep their portion of the gain, if you sell for a loss, the government will also make a proportional loss. This scheme will apply to properties below $850,000 (Melbourne).
Solution Comparison:
- First Home Loan Deposit Scheme
- Higher monthly repayments
- Higher minimum deposit (5%)
- Keep all changes in market value
- Minimal terms and conditions after purchasing
- Help To Buy Scheme
- Government become part owner in the property
- Lower loan amount and repayments
- Lower minimum Deposit (2%)
- Share the market value changes with Government
- Strict income thresholds and repayment conditions
The Important Trade-Off To Consider – Valuing Now Or Later?
Although a 5% deposit reduces the upfront cost to the homebuyer, the long term downside of providing a minimal deposit is that these loans charge highest interest rates, as the lender needs to compensate for the borrower having a small stake in the property. Lower deposits lead to the borrower paying significantly more interest over the loan life compared to higher deposits. As a homebuyer, you should consider if you value purchasing a home quicker or if you prefer to delay purchasing to build up a larger deposit, and receive the benefits of cheaper interest rates.
Common Strategies:
- Rising Housing Market
Although over a full 30 year loan term, a low deposit mortgage will cost more compared to a higher deposit mortgage, a common strategy to save on loan repayments is for mortgage brokers to help refinance the old high interest loan, into a new lower interest rate loan after a year or two. Over this period, the borrower will generally receive a pay rise at work, have a history of consistently making loan repayments and experience a rise in the market value of their property. The rise in the value of the property increases the borrowers ‘equity’ (stake) in the home, which represents a higher deposit in the property, allowing the refinance to a cheaper interest rate, saving on repayments. This strategy is most effective during a rising housing market.
- Falling Housing Market
The forecast cash rate rises over 2022 and part of 2023 could see house prices fall 10-15%, resulting in increased variable interest repayments and reduced equity in homes. In this environment, borrowers should be actively contacting their mortgage brokers to exploit competition among lenders by refinancing to the best interest rates available. The MJ Financial Chiefs are zero-fee mortgage brokers, helping borrowers actively seek the best interest rates without being hampered by fees charged by other brokers.
Conclusion – Utilise Your Broker!
The property purchasing process is complex, with many variables that change the ideal strategy home buyers should take in order to minimise monthly repayments, get the best interest rate, and achieve a solution which best suits their goals. A seen above, there are strategies home buyers can take to minimise or remove paying costly Lenders Mortgage Insurance fees, however the takeaway is to utilise your broker, whose knowledge in the area will save you the time and hassle of researching yourself. Contact the Chiefs for a tailored answer to your questions and situation. We are Zero-Fee Mortgage Brokers!