How does a low deposit home loan work?
Low deposit home loans only need a 5-10% deposit, instead of the standard 20% of the property’s value most lenders require. You’ll have to pay lender’s mortgage insurance (LMI) to mitigate the lender's risk, unless you apply through a government scheme or have a guarantor. You generally need a 20% deposit of the property’s value to avoid LMI.
Buying a home with a low deposit is possible, but it’s important to understand that it may result in a higher interest rate and an LMI premium.
A low deposit means a higher loan-to-value ratio (LVR)
Your deposit will determine your loan-to-value ratio (LVR) and ultimately the interest rate on your home loan. LVR is your loan amount expressed as a percentage of your property's value. If you have a 20% deposit, your LVR will be 80%. Lenders generally consider LVRs north of 80% riskier and may charge higher interest as a result.
A low deposit home loan allows you to borrow between 80% to 95% of a property’s value, but you may pay LMI to offset the risk of default. LMI can be added to your home loan amount, so you don't have to pay it upfront.
Home loan deposits and their corresponding LVRs
| Deposit | LVR |
|---|---|
5% deposit | 95% LVR |
10% deposit | 90% LVR |
15% deposit | 85% LVR |
20% deposit | 80% LVR |
25% deposit | 75% LVR |
30% deposit | 70% LVR |
A low deposit means you may need to pay for pay LMI
A low deposit home loan will likely incur lender’s mortgage insurance (LMI) — a one-off insurance premium that covers the lender against the risk of default. LMI is calculated on a tiered scale, based on your deposit and property's value. Each lender will calculate LMI differently.
Considering how hard it can be to save up a 20% deposit, many buyers choose a low deposit home loan, even with the LMI cost added on.
Examples of LMI cost on a low deposit home loan
Property value | |
Loan with 20% deposit | $600,000 |
Loan with 10% deposit | $600,000 |
Loan with 5% deposit | $600,000 |
Loan amount | |
Loan with 20% deposit | $480,000 |
Loan with 10% deposit | $540,000 |
Loan with 5% deposit | $570,000 |
Deposit amount | |
Loan with 20% deposit | $120,000 |
Loan with 10% deposit | $60,000 |
Loan with 5% deposit | $30,000 |
LVR | |
Loan with 20% deposit | 80% |
Loan with 10% deposit | 90% |
Loan with 5% deposit | 95% |
LMI amount | |
Loan with 20% deposit | $0 |
Loan with 10% deposit | $22,835 |
Loan with 5% deposit | $26,305 |
| Loan with 20% deposit | Loan with 10% deposit | Loan with 5% deposit | |
|---|---|---|---|
Property value | $600,000 | $600,000 | $600,000 |
Loan amount | $480,000 | $540,000 | $570,000 |
Deposit amount | $120,000 | $60,000 | $30,000 |
LVR | 80% | 90% | 95% |
LMI amount | $0 | $22,835 | $26,305 |
Cost of a low deposit home loan vs a larger deposit
Low deposit home loans are usually more expensive over the long term compared to a loan where the borrower has a 20% deposit. That's because you'll likely pay a higher interest rate, potentially have LMI to pay for, plus higher interest costs overall on account of the larger loan balance.
Here’s an example of what the difference may be on two comparable loans with a 6.00% interest rate and a 30-year loan term. The only difference is the deposit size.
Costs compared: 5% deposit vs 20% deposit
Property value | |
Low deposit home loan (5%) | $600,000 |
Full deposit home loan (20%) | $600,000 |
Interest rate | |
Low deposit home loan (5%) | 6.00% p.a. |
Full deposit home loan (20%) | 6.00% p.a. |
Loan amount | |
Low deposit home loan (5%) | $570,000 |
Full deposit home loan (20%) | $480,000 |
LVR | |
Low deposit home loan (5%) | 95% |
Full deposit home loan (20%) | 80% |
Deposit | |
Low deposit home loan (5%) | $30,000 |
Full deposit home loan (20%) | $120,000 |
LMI cost* | |
Low deposit home loan (5%) | $26,305 (added to loan) |
Full deposit home loan (20%) | $0 |
Monthly repayments | |
Low deposit home loan (5%) | $3,575.15 |
Full deposit home loan (20%) | $2,877.84 |
Total interest payable | |
Low deposit home loan (5%) | $690,749 |
Full deposit home loan (20%) | $556,023 |
Total to repay | |
Low deposit home loan (5%) | $1,287,054 |
Full deposit home loan (20%) | $1,036,023 |
| Low deposit home loan (5%) | Full deposit home loan (20%) | |
|---|---|---|
Property value | $600,000 | $600,000 |
Interest rate | 6.00% p.a. | 6.00% p.a. |
Loan amount | $570,000 | $480,000 |
LVR | 95% | 80% |
Deposit | $30,000 | $120,000 |
LMI cost* | $26,305 (added to loan) | $0 |
Monthly repayments | $3,575.15 | $2,877.84 |
Total interest payable | $690,749 | $556,023 |
Total to repay | $1,287,054 | $1,036,023 |
In this example based on a $600,000 home loan, the low deposit borrower pays:
- An LMI premium of $26,305
- An extra $697 in monthly repayments
- $134,726 more in interest over the life of the loan (with LMI added to the loan)
The low deposit home loan results in having to repay $251,031 more compared to a full deposit home loan.
Is a low deposit home loan still a good idea?
Even with the added costs involved, many borrowers choose to apply for a low deposit home loan. Here are some reasons why:
- It can help you enter the property market sooner instead of waiting years to save a 20% deposit (by which time property prices could have gone up).
- You can stop renting and start paying off your own mortgage.
- You can build equity in your home immediately as you pay down your home loan.
- If you use a guarantor, a low deposit means you may have additional funds available for renovations or improvements that can add value to your property over time.
- Owning a property sooner means you can benefit from capital growth sooner.
- There are government grants and schemes designed to help borrowers with a low deposit save on the cost of LMI (more on this below).
For many buyers, a low deposit home loan may be their only option to buy property. This may be the case for first-home buyers, low-income earners, single parents, self-employed individuals or casual workers.
You need a clear picture of the costs of a low deposit home loan and a strategy to minimise these over time. For example, you can use an offset account to reduce your interest payable or increase your repayment frequency to fortnightly to pay off your mortgage early and save thousands in interest.
Mansour Soltani , Money's home loan expert
“A low deposit home loan can be a good way to get into the property market, but these loans are more expensive, so we recommend that you have an exit strategy. For example, if you’re using a lender who charges more fees/higher interest, use this avenue to get onto the property ladder but also make a plan to refinance to another lender once you have paid some of the loan down, the value of your property increases and/or your salary has increased.”
Mansour Soltani , Money's home loan expert
Low deposit home loan pros & cons
Pros
- You can purchase a home without saving a large deposit
- Buying a property sooner may help you to build equity and benefit from capital gains sooner
- You can generally refinance to a cheaper home loan product when you increase equity in the property
- Successfully managing a low deposit home loan can positively impact your credit history
Cons
- Higher costs, including LMI
- May have higher interest rates than the average home loan
- Higher principal amount, which means higher repayments, and more interest payable over the life of the loan
- Not all lenders offer low deposit home loans
Low deposit home loans for first-home buyers
Low deposit home loans are especially popular among first-home buyers as a way to crack the property market. For many buyers, it may be the only way to buy a home without help from the bank of mum and dad. Luckily, there are a number of options available to first-home buyers who want to buy a home with a small deposit.
Home Guarantee Scheme (HGS)
The Home Guarantee Scheme (HGS) is a federal government initiative to help eligible home buyers purchase a home with a deposit of as little as 5% without paying LMI. Housing Australia guarantees the remaining 15%. The Home Guarantee Scheme is only available through participating lenders. There are a few different avenues available to home buyers through HGS programs, including:
1
First Home Guarantee (FHBG)
Supports eligible first-home buyers to buy a home with a deposit starting from 5% and avoiding LMI.
2
Regional First Home Buyer Guarantee (RFHBG)
Supports eligible first-home buyers to buy a home in a regional area with a deposit starting from 5% and avoiding LMI.
3
Family Home Guarantee (FHG)
Supports eligible single parents and eligible single legal guardians of at least one dependent to buy a home with a deposit starting from 2% and avoiding LMI.
Most states and territories also have the First Home Owner Grant (FHOG), which provides a one-off, tax-free payment to first-home buyers to purchase a new home.
Guarantor home loans
With a guarantor home loan, some lenders may allow you to borrow up to 100% of property's value, meaning you would not be required to put down a deposit at all. This is sometimes known as a no deposit home loan, and terms and conditions apply (e.g. your guarantor must be an immediate adult relative).
It's a riskier option for both the borrower and guarantor. If you can't repay the debt, the lender can sell your home to recover the debt and put a caveat on your guarantor's property too.
How to apply for a low deposit home loan
Applying for a low deposit home loan may require more documentation and preparation than a standard home loan.
1. Check your eligibility
The eligibility criteria for low deposit home loans are often stricter than for a standard home loan, as lenders consider them riskier. Firstly, make sure your credit file is squeaky clean with no defaults or missed payments (otherwise you may need to consider a bad credit home loan).
Lenders will look at your credit score, income and savings (including balances of savings accounts and term deposits) to assess your eligibility for a low deposit home loan. Some lenders may impose restrictions on the type of property you buy or certain postcodes.
2. Gather your supporting documentation
Home buyers with a low deposit may be asked to provide more paperwork than those with a 20% deposit. Standard paperwork generally includes:
- Proof of income, including two payslips for the year to date or tax returns for the year to date if self-employed
- Details of your assets and liabilities
- 100 points of ID (e.g. driver’s licence, passport)
Additional paperwork for low deposit home loans includes:
- Bank statements showing your deposit has been accrued over time and sitting in a bank account for at least three months OR
- A tenant ledger or rental reference letter signed by a real estate or property manager confirming you’ve always paid rent on time.
3. Complete the lender’s home loan application form
Fill out the lender’s home loan application form with all your relevant information and follow the instructions. You may be asked to upload your supporting paperwork at this stage or after the lender assesses your borrowing capacity.
You should notify your lender if you have a guarantor for your home loan or if you intend to use the First Home Guarantee (FHBG). Your lender will handle the paperwork on both counts.
4. Get pre-approved for a low deposit home loan
After an initial credit check, you may get pre-approval (or conditional approval), which confirms you qualify for a low deposit loan and for how much. Once you’ve secured pre-approval, do not make any changes to your financial situation or employment status. Your lender can still deny your application for formal approval if your circumstances have changed.
5. The lender will conduct a credit check
The lender will conduct a complete credit check before processing your home loan application to the next stage. They will pay close attention to any outstanding debts, missed payments or defaults. It’s best to get ahead of the curve with this one, so check your credit score and report for free before you apply for a home loan.
6. Get unconditional approval
You can get unconditional approval when you find a property to buy and valuation is finalised. Your lender will issue a formal loan offer detailing the terms and conditions of the loan, including your rate. Review the loan offer and sign it if you accept the terms.
5 tips to get a home loan with a low deposit
1
Speak to a mortgage broker
Speak to a mortgage broker about how to get the best low deposit home loan for your financial situation and goals. They will also know which lenders offer this type of product and which are more likely to accept your application.
2
Tidy up your spending
Your lender will want to see a history of responsible spending, especially if you have a low deposit. Make sure to reign in all your discretionary spending at least six months prior to applying for a home loan. Lenders will look at your bank statements to see where your money is going.
3
Pay off your debts
Debt affects your ability to make repayments and may imply that you’re spending more than you earn. Prove to your lender that you’re financially responsible by paying off some debts before you apply, particularly high-interest debt like credit cards, personal loans, or car loans.
4
Bump up your savings
Genuine savings is money you’ve earned and put aside yourself (e.g. in a high-interest savings account). It shows lenders that you can manage your finances and that you’ll be able to make the repayments. The more you save, the better your application will appear.
5
Use government incentives and grants
Make use of government incentives like the Home Guarantee Scheme (HGS) or First Home Owner Grant (FHOG) to get you into your dream home with a smaller deposit and potentially save on LMI. Places may be limited, so check your eligibility before you apply.
