Glen McLeod, director of Edge Mortgages, says it can be more expensive to have a small deposit.
Glen McLeod is director of Edge Mortgages. He will answer readers’ questions about home loans, whether you are a first-timer just getting into the market or someone who already has a loan and is wondering about the best way to manage it. If you have a query, email [email protected]
How much extra will we have to pay in low-equity fees and higher interest rates if we buy with a 15% deposit? Is it worth holding on until we have saved 20% before we try to buy?
There are a number of factors that you need to take into account when deciding whether or not to purchase with the lower deposit or wait until you have reached your 20% target.
One of those factors is the housing market that you’re in at the time. If house prices continue to go up as quickly as they have been over the last few years then it may be in your best interest to purchase with a lower deposit.
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That is because, when you are dealing with rising house prices, you are also dealing with continual adjustment of what your 20% deposit looks like. In saying that, the current climate is showing a reduction of house prices so you don’t really need to take this particular factor into account if purchasing in today’s market.
Then it comes down to lenders’ policy around their low-equity fees or lower-equity margins. As you can imagine each lender has its own way of calculating either a low-equity fee or a low-equity margin. So you need to understand the difference between the two before saving to achieve a 20% deposit.
So what are they and what do they cost?
Low Equity Fee (LEF)
In the case of a fee, it is based on the value of the loan times a percentage (based on your loan-to-value ratio). For example if your loan was $500,000 and your loan-to-value ratio was 80.01% to 84.99% the percentage of fee would be 0.25%, or $1250. But if your loan-to-value ratio was 85% to 89.99%, the percentage would be 0.75% and your fee would be $3750. This would be a one-off payment at the beginning of the loan, either paid outright or added to the loan. If you choose to add it to the loan you would then be charged interest on that fee over the lifetime of the loan, making it much more expensive in the long run.
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Low Equity Margin (LEM)
In the case of a low-equity margin, it is based on a similar calculation but instead of being a fee added at the start of the loan it becomes an interest rate percentage added to the rate you are given. For example if the loan was $500,000 and your loan-to-value ratio (LVR) was 80.01% to 84.99% then the margin would be 0.25% to 0.35% depending on the lender. For example, if the interest rate given to you was 6.49% for one year then 0.25% is added to that rate, making your interest rate 6.74% (approximately an extra $1250 p.a.). Above 85% LVR would be 0.75% so 7.25% would be your new increased rate.
Until your loan-to-value ratio reduces to less than 80% the rate will apply, therefore it can cost a lot more over time. The best thing to do is reduce the loan as quickly as possible. In the case of a low-equity margin, once you get the loan-to-value ratio below 80% the margin can be removed. However, this can mean the breaking of your fixed rate which may involve a break fee.
One thing to look out for is that the interest rate you receive is not the 80% special, you end up with the standard rate plus the margin which will be much higher.
If your deposit is under 20% and within the income and house price caps, you may be able to apply for a Kainga Ora First Home Loan. This would mean you would receive the under 80% interest rates, as Kainga Ora effectively covers the risk above 80% loan-to-value for the lender. It charges you a 1% fee of the loan amount ($5000 based on a $500,000.00 loan).
There are a number of options to choose from. The key is understanding the cost and what the market is doing. Then you will be able to weigh this all up against the time it takes for you to save the extra 5% deposit. Be mindful that while you are saving the extra deposit you could be paying rent and that needs to be factored in to your calculation.
An easy option is to contact a qualified mortgage adviser who will be able to discuss all your options available with each lender.
