The risks of a smaller home deposit

Many Australians aspire to own property, an ambition which usually requires them to take out a home loan. A challenging aspect of the home loan process is putting together a deposit — but the smaller the deposit, the more risks there are.

The desire for a quick deal

Tony Cahill, legal author, recently voiced concerns about limited deposits in the context of home buying.

With pressure to secure a deal, some real estate agents are accepting smaller deposits on behalf of vendors. Coupled with lenders’ increasingly liberal approach to providing home loans, more buyers may find themselves snapping up real estate without having to save hefty deposits.

“They often recommend that it is a good idea for the vendor to get a quick exchange, and when this occurs there will often be an additional clause included which tries to ensure that if there is a default by the purchaser then the deposit will be ‘topped up’ when default occurs,” Cahill told the Real Estate Institute of New South Wales.

However, there are risks with this approach.

Smaller deposit, bigger risks

Despite some purchase and sale agreements including a clause requiring a deposit top-up in certain instances, this is not necessarily the best approach, according to Cahill.

In many instances, legal action is required, with the effectiveness of the clause tested in a court of law.

“Even if the clauses are effective, then the vendor is behind the eight ball because instead of having ten percent with the agent they only have the lower amount and usually the reason the purchaser is not finalising the deal is because they do not have the money to continue,” Cahill noted.

Such observations may encourage sellers to re-think the terms of the sale and purchase agreement they’re entering into.

Extra costs for buyers

It’s not just sellers who could find themselves stuck between a rock and a hard place.

Those looking to step onto the property ladder may feel the pressure of saving up for a deposit. While it can take some time for a savings account to reach a healthy sum, there’s a significant financial incentive to save up for longer and secure a decent deposit.

Purchasers with a deposit less than 20 percent of a property’s value may be able to secure a loan, provided they take out Lenders Mortgage Insurance (LMI).

Bridget Sakr, Genworth Chief Commercial Officer, recently noted that strong real estate value growth and the challenge of coming up with a deposit is making home ownership difficult for first-time buyers.

“This ongoing challenge for many Australians highlights the value of low deposit options such as LMI, which can help people enter the property market with a deposit as low as five percent,” Sakr stated.

But it’s important for home buyers to be aware that LMI is designed to protect the lender in the case of a default — not the borrower! It’s also a cost that’s passed on to the borrower.

This means thorough budgeting is essential, so new homeowners can be confident they’ll be able to pay off their loans over the years.

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