Should you buy a home with a 5% deposit?

With property prices softening and interest rate hikes on the horizon the question is, is now a good time to be buying a home with as little as a 5 per cent or 2 per cent deposit?

Here are 3 things you need to know before you jump in. 

You can save on LMI

To avoid paying lenders mortgage insurance (LMI) you typically need to have a 20 per cent deposit. If your deposit is less, then LMI applies and this is not cheap. 

On a $700,000 property with a 5 per cent deposit, the insurance – which, by the way, protects the lender not you – could set you back as much as $28,000. 

The big drawcard of these schemes is that you avoid LMI. Thanks to the government stepping in and providing a guarantee of up to 15 per cent of the purchase price, LMI is not needed. 

Of course by jumping in with just a 5 per cent deposit the other big plus is that you can buy sooner.

Based on the median dwelling value across Australia at the end of February ($728,034), CoreLogic estimates it would take around 2.3 years for the median household to save a 5 per cent deposit on a home. 

A 20 per cent deposit would take around 8.8 years. This time difference means you can also stop paying rent sooner.

You risk owing more than you own

A 5 per cent deposit means you will need to borrow more, which in turn  means your total interest bill could end up costing you more. The other disadvantage is that not all lenders offer these home deposit schemes, meaning some of the cheapest home loans may not be available to fund your purchase. 

Then there’s the risk of negative equity. If property prices fall you could find yourself in a situation of owing more than you own. 

This becomes a problem if you have to sell. If you are able to hold onto your property then in the long term you should be able to ride out the bumps. 

According to CoreLogic, the last peak to trough decline saw property prices fall nationally by 10.2 per cent, with regional areas faring a little better.

It doesn’t solve home loan affordability

Maximum purchase prices (property price caps) are applicable for eligible properties purchased under the First Home, Family Home and New Home Schemes. Details around the property caps for the Regional Scheme are yet to be released.

The price caps vary according to the financial year in which your scheme place was reserved, and where your property is located (in a capital city, large regional centre or regional area).  

There’s been a lot of debate around whether or not these thresholds are too low. For example, in Brisbane to qualify for the First Home Scheme, the home must cost less than $600,000, which is somewhat difficult given the median dwelling value is around $856,000.

CoreLogic estimates around 35.4 per cent of Australian established dwellings would qualify under the current caps, but big variances apply with qualifying properties ranging from up to 66.3 per cent of dwellings in Perth, to just 10.7 per cent in the ACT.

If property prices fall, more dwellings will free up, while the reverse is true if prices rise.

The problem here of course is that you can increase the property caps all you like, but that doesn’t mean borrowers afford the repayments, as income restrictions also apply. 

To be eligible for any of the schemes, a taxable income of up to $125,000 per annum applies for single applicants, and a taxable income of up to $200,000 per annum for couples.  

If you increase the income thresholds you defeat the purpose of having schemes that help low income earners into the property market.

The bigger issue here is that unfortunately these schemes do not solve home loan affordability. In fact it could do the very opposite. By increasing demand for more affordable properties, prices in this segment could increase.