In Australia, when you purchase a property, the lender will lend you 80% of the ‘value’ of a property (unless of course you take out mortgage insurance – more on that and why you should try to avoid it in just a moment); so as a deposit you need to be able to pay for 20% of the ‘value’ of the property, plus more.
Your lender will lend you up to 80% of the ‘value’ of the property.
The ‘value’ is not how much you pay for the property.
The ‘value’ of the home you purchase is the amount an independent valuator (who your lender will hire) will value the property at.
And it can be lower than the amount you will pay for the home.
When we purchased our first property we purchased it at a good price, we negotiated well, and we knew you couldn’t purchase a house like it at that time (or since that time) for that price. But when our property was valued, it was valued at $15,000 less than what we were paying.
We were shocked.
Very shocked.
We weren’t prepared for a lower valuation as we had no idea that this was even possible (having never purchased a property before). And how would you ever find out? No real-estate agent is going to tell you, “Come and check out this beautiful property; by the way, it will be valued at $30,000 less than what you are about to pay for it!”
Well, no real-estate agent had ever said that to us before anyway!
When a home is valued at less, the lender will still only lend you up to 80% of the ‘value’ of the property, not what you actually pay for it.
And what does that mean for you?
You need to have extra money aside to be able to pay for that extra amount you purchase that is above the valuation conducted.
You need the 20% deposit, plus extra to offset the valuation in case the value is lower than the amount you paid for the property.
In our case, we had to have an extra 80% of the $15,000 shortfall, which was $12,000. We had to have an extra $12,000 to pay upfront.
We were lucky, we had extra money on the side to help us over that hurdle. You could encounter the same issue, so be ready for it.
And what if you don’t have the extra money?
Banks may still lend you more than 80% of the loan if you take out mortgage insurance; but then you really pay for it.
Lenders will happily loan you more than 80% of the ‘value’ of the property on the condition that you take out mortgage insurance.
But this insurance is expensive.
Very expensive.
Lenders will also happily add the additional cost of the mortgage insurance to your home loan (so you end up with a bigger loan; and remember what happens with bigger loans—you pay more in interest over time and it takes longer to pay off).
This does not work in your favour.
For example, if the value of the property you purchase is $500,000, and you borrow 95% of the property price— $475,000—the mortgage insurance will cost you over $15,000, and that amount will be added to your home loan—so you end up with a loan of $490,000, not $475,000.
Since interest accumulates over time, you end up paying for this in the long run (it will take you longer to pay off your home loan and you will pay more interest overall). If your interest was 5% and your repayments were $1,150 per week, this is like paying it off for an extra half or full year, and possibly paying an extra $20,000 in interest.
Because mortgage insurance adds an extra amount to your home loan, if you want to stick to your time frame, you will need to make higher regular repayments to pay it off or change your time frame.
So, what can you take from this?
If you are a first home-buyer, try to avoid taking out mortgage insurance.
If you can, don’t do it.
It will make it more difficult for you to repay your home loan faster.
Try to stay within your own limits for buying and don’t add any unnecessary debt to your loan.
Read on to the next blog post where we talk about shopping around for a home loan!