This article is part of a fictional case study series following "Sarah", a typical first home buyer in Victoria. Read each article to follow "Sarah" through a variety of articles exploring issues related to buying a home.
After four years of saving, Sarah was getting closer to her goal. But she kept coming up against the same question: how much do I really need to set foot in my own house?
That’s a complex question, because it’s not just about whether your deposit will be enough to buy you a home. It’s about understanding whether that deposit will be enough to get a cheaper interest rate, or even stop you from having to pay Lenders Mortgage Insurance (LMI).
At a minimum, first home buyers need 5% of their deposit to come from savings. That means money they've saved on their own, not gifts or from family. And that doesn't even take into account costs like conveyancing and stamp duty!
After four years of diligent saving, Sarah had saved up $50,000 for a deposit. That was enough to get her a 20% deposit on a $250,000 house, or a 10% deposit on a $500,000 house.
So what are the pros and cons of each situation?
If Sarah pays 10%, she’ll get into a better house, in a better location. But it’ll also mean she has higher mortgage payments – approx. $2148 on a 30-year mortgage at 4%. That’s more than 58% of her take-home pay each month! Not to mention, she’ll need to pay Lenders Mortgage Insurance (LMI). That’ll add more to her repayments.
If Sarah pays 20% on a $250,000 house in the same suburb, she may end up with a smaller property (more like a small apartment). But her repayments will only be 25% of her take-home pay, which is much more sustainable. Plus, she won’t need to pay Lenders Mortgage Insurance (LMI).
There are other things to consider. A bigger home at $500,000 is probably going to appreciate more in value than an apartment. And Sarah can always get roommates to help offset the rent – those will help in long-term financial planning and achieving independence.
On the other hand, a bigger house means higher utility and repair costs, which eat into day-to-day living. It also means Sarah has a bigger financial weight around her neck if she happens to lose her job for any reason.
In the end, Sarah decided to compromise by putting down $50,000 on a $375,000 flat in the outer suburbs – a deposit of 13%. It isn’t quite 20%, but it’ll help reduce her repayments and maintenance costs. Plus in about five years, she figures it may have appreciated enough that she can always refinance.
How much should your deposit be? Well, how long is a piece of string? It really only counts as to how much risk you’re willing to take on. Run the numbers yourself, judge them against your own income, then decide on the most appropriate course that will keep you financially afloat.
Sarah would love a bigger house right away, but she doesn't want to be paying off a huge mortgage straight away either. Compromising should get her a modest place with a repayment she can afford.