The Extra price of having a lower deposit

1 March 2016
Last week, one of the major trading banks introduced new measures for those customers obtaining loans with less than a 20% deposit. The first thing that you may find surprising about that statement is that a main bank is able to offer a home loan above 80% of the value of the property. Let us quickly clarify that the qualification criteria is much tougher to get a loan approval at that level as lenders only have a certain percentage of their total borrowing that they can provide at a higher LVR, so they tend to save those loans for the higher quality (i.e. higher earning) clients. However, we have seen a number of our clients obtain loans to purchase their first homes without the 20% equity that the banks may suggest is required.
The second point however relates to the extra costs associated with home loans when you have a smaller deposit. The first of these is a Low Equity Margin or Low Equity Premium. These are amounts added to the cost of your loan to cover the banks self-insurance costs in case of non-payment of your borrowing leading to a loss from a forced sale. The bank in question at the start of the article used to apply a low equity premium to borrowing that was above 80% which could either be paid as a one off expense or added to the loan. The Low Equity Premium (LEP) is calculated depending on how high above 80.0% your borrowing sits and we have seen variations of around 1% between lenders fees in the past. Given that the size of the LEP sits between 0.75-2% of the loan amount, the extra cost can be significant. On one occasion at the start of the year, the cost difference to the client between two banks offers amounted to nearly $6,000 purely because of the LEP charges on their borrowing.
The other method of calculating an extra cost which has now been adopted by most lenders is a Low Equity Margin (LEM). This is an extra percentage added to the standard interest rates, which remains in place while your borrowing remains above 80.0% of the property value. This can work out a much better option for those who are planning on attacking at least a portion of their debt or expect their property to increase in value, as they can revert to a lower interest rate once they have 20% equity in the home. Obviously, it is important to review your lending position with your adviser on a more regular basis if you are setting up your lending with a view to getting onto special discounted rates as quickly as possible and these plans should be discussed when working out your preferred loan structure. In some cases it may actually be possible for your adviser to get you a reduced interest rate so that once the LEM is applied, the finished interest rate being charged is not much higher than the standard available rates.
But it is not just the extra LEM and LEP costs that can cause your loan to cost more if you have a lower deposit. Most lenders will request a Registered Valuation to be carried out for any loans with less than 20% deposit to put towards the purchase. This once again gives the bank some peace of mind around what is classified as higher risk lending, but at a cost between $5-800, can be a significant outlay for those with limited funds. Also, it is unlikely that the banks will offer the same type of cash incentive for those purchasing with a smaller deposit and we heard recently that one bank will not offer any cash contribution to help out towards associated home loan expenses for those.
If you are considering purchasing in the current buoyant market to take advantage of the continued low interest rates, but don’t yet have a full 20% deposit, then it may be worth having a chat with your local registered home loan adviser to discuss which options are most suitable, and which bank is going to provide the most cost effective deal personal to you?

Published In Whakatane Beacon

This post was written by

John White - who has written 90 posts

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