Should aspiring owners buy now or keep saving?
Mark and Robyn want to buy a home.
They've only saved around 10% of the price they expect to pay but, with interest rates at record lows and property prices on the rise, do they bite the bullet and borrow more to buy now?
Or do they wait, save some more and take the risk that by the time they've saved a 20% deposit they could be out of the market again and have to wait even longer?
It's a real dilemma for budding home buyers - buy now, or wait and save? The answer, of course, rests on your personal situation and whether or not you believe where you want to buy is on the rise.
Let's say Mark and Robyn live in Sydney. They have their eye on a two-bedroom unit priced at $500,000.
They know they need a deposit of $100,000 if they are to avoid lenders mortgage insurance (LMI).
They're paying $480 a week in rent. They can afford to save $1400 a month towards their first home.
Even with $50,000 already tucked away in an online saver, it would take them further 2 and a half years to reach their $100,000 target.
Having read last month's issue of Money magazine, Mark and Robyn are all too aware that economic forecaster BIS Shrapnel has singled out Sydney as the state with the strongest property outlook.
Its prediction: a 19% jump over the three years to June 2016, which means an average 5.9%pa for the three years.
If BIS Shrapnel is right, by the time Mark and Robyn save their $100,000 deposit that $500,000 property would have increased in value by a just over $90,000, meaning they would need to save a further $18,000 to have a 20% deposit.
LMI protects the lender in the event that you default on your loan and what you owe is greater than the sale price of the property.
It's not portable, so if you refinance with a new lender before your equity has reached 20% of the property's value, you'll have to pay it again.
LMI isn't cheap - around 2% of the loan amount. If Mark and Robyn buy now, the one-off premium would be around $9000.
At first glance it makes sense for them to buy now.
After all, the LMI premium is only half the cost of what the deposit increase would be if they wait and save.
For first-home buyers, there's also the option of using the first home owners grant (FHOG) to pay the premium. But a few more sums show it's not that simple.
For starters, Mark and Robyn are borrowing more - $59,000 more - if they buy now.
They also need to capitalise the LMI premium on their home loan as they are ineligible for the FHOG.
While this increases their monthly repayments by just $80 a week compared with the full 20% deposit case, over a 30-year term the extra borrowings would cost them and extra $55,000 in interest (see table).
Of course, if Mark and Robyn can save more than $1400 a month and put it into the mortgage as extra payments, the notion of buying now can work for them.
There's always a risk when it comes to borrowing more. If there wasn't then lenders would not insist on mortgage insurance. While the insurance protects your lender, the risk for you as a highly geared borrower is negative equity.
Should interest rates increase or property prices decrease, you could find yourself in a situation where your loan is bigger than the value of your home. Even if you can still afford the repayments, negative equity essentially locks you in as you won't be able to afford to upgrade.
If you need lenders mortgage insurance to buy a home, make sure you do your sums first so it is truly in your favour and not in your lender's interest.
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