Hard-saved deposits can be left in the dust by fast-rising house prices, leaving first home buyers with a tough choice.
The advice is often that buyers should save until they have 20 per cent of the purchase price, which lets them take advantage of lower interest rates, though banks frequently lend to those with only a 10 per cent deposit provided they fulfil certain criteria.
The big dilemma for buyers in a fast-moving market is whether to save for even longer to catch up to the ideal 20 per cent deposit banks love, or whether they should go out and buy now even though their deposit is lower, meaning the interest rate they can get will likely be higher.
The answer, says Rupert Gough, CEO and founder of the Mortgage Lab, is to buy now.
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Gough has been running the numbers and says while saving for a bigger deposit might feel like the right thing to do, that may not be the smartest financial choice.
Key in the decision-making process is understanding that:
- a mortgage of 90 per cent of the purchase price has a higher interest rate, typically around 4.8 per cent
- a mortgage of less than 80 per cent gets the good rates, of around 3.4 to 3.5 per cent
The question, therefore, is should someone with a 10 per cent deposit purchase today and pay the higher interest rate, or should they continue to save and try to get a 20 per cent deposit so they can access the lower interest rate?
Gough uses a $500,000 value house as an example which assumes there is no access to “the bank of mum and dad” for the deposit and that first home buyers have saved the 10 per cent minimum so they have a $50,000 deposit.
“The first question they would want to ask themselves is, how long will it take to save a further 10 per cent deposit so they can get into that sweet spot for interest rates?
“It could plausibly be two to three years to save an additional $50k and the concern for most home buyers is that in the meantime the housing market has jumped up and now the same house is valued at $600k.”
In order to get themselves onto the cheaper interest rate, that delay has just cost them an additional $100,000 on the purchase price, Gough says.
“The struggle that first home buyers face is that paying a higher interest rate sounds like it’s a worse option - but an additional 1.3 per cent interest on a $450k mortgage is around $5,850 per year.
“Even over three years, that’s just over $17k additional interest as opposed to waiting and paying $100k more for the same property.”
But what if houses don’t grow in value that fast? Gough asks.
Even if the same house in three years time has only gone from $500k to just $517k, you still break even, he says.
“And if the market is flat you have had the opportunity to improve your home in the meantime through renovations, something that is not possible if you are renting and continuing to save.
“The numbers seem to show that, assuming you can comfortably afford the mortgage, purchasing early is a better scenario than waiting to save more deposit.”
