5% deposit versus 20% deposit

[spludgey]

Most people that invest in real estate seem to put 20% deposits down so that they can avoid LMI.

What I have been doing for the last two properties was buy them with 5% deposits. This means that you can buy at least twice as many properties as you could if you used a 20% deposit.

As LMI comes into play, obviously your returns are going to be somewhat reduced due to the increased loan size. But I have found that it's only 2-3%, so it doesn't make a huge difference.

If the properties that I buy have a rental return of 7.5% and I can get money for 5.5%, that means that my overall cash flow will be higher buying two properties using a 5% deposit as opposed to one property with a 20% deposit.
While the initial equity is going to be less, the higher leveraging should fix that after a couple of years.

Is there a problem with this strategy? I'd like to hear your views on it.

 

[Scott No Mates]

It is a method used by plenty of people as you tie up less of your cash in each deal and have the reserves to continue buying.

 

[Rolf Latham]

Most people that invest in real estate seem to put 20% deposits down so that they can avoid LMI.

What I have been doing for the last two properties was buy them with 5% deposits. This means that you can buy at least twice as many properties as you could if you used a 20% deposit.

As LMI comes into play, obviously your returns are going to be somewhat reduced due to the increased loan size. But I have found that it's only 2-3%, so it doesn't make a huge difference.

If the properties that I buy have a rental return of 7.5% and I can get money for 5.5%, that means that my overall cash flow will be higher buying two properties using a 5% deposit as opposed to one property with a 20% deposit.
While the initial equity is going to be less, the higher leveraging should fix that after a couple of years.

Is there a problem with this strategy? I'd like to hear your views on it.

Pros and cons

Con

1. Its not a sustainable strategy to build a bog portfolio. LMI providers and lenders that will do 95s will only do so untilthey are over exposed to you, at which point they will find a reason to decline otherwise good deals

2. Over 300 k and certainly over 500 k the LMI premium becomes questionable, especially where you cant add the LMI to the 95 %. In that case the 90 + cap LMI vs the 95 minus LMI has mraginal bebefit

3. Lenders credit score you really hard for 95s, so what might be an easy90 + cap under the lenders DUA ( they can approve their own LMI deals) becomes a trial at 95

4. If you fall into arrears dont expect any mercy at that LVR .........


Pros

1. Leverage, and rope, this can be a con too

2. Transfer risk to a third party

3. Hold more of your cashback for challenge or opportunity

4.Retain cash for non tax ded purchases

t
arolf

3.

 

[Brady]

Pros and cons

Con

1. Its not a sustainable strategy to build a bog portfolio. LMI providers and lenders that will do 95s will only do so untilthey are over exposed to you, at which point they will find a reason to decline otherwise good deals

Not sure how many lenders consider 95% good deals. They do them because they are deals, but usually not considered good.

Note that I'm happy to operate the same way way borrowing 95% and recommending it, but banks don't consider them good deals. Good deals to them are <80%

 

[Rolf Latham]

Pros and cons

Con

1. Its not a sustainable strategy to build a bog portfolio. LMI providers and lenders that will do 95s will only do so untilthey are over exposed to you, at which point they will find a reason to decline otherwise good deals

Not sure how many lenders consider 95% good deals. They do them because they are deals, but usually not considered good.

Note that I'm happy to operate the same way way borrowing 95% and recommending it, but banks don't consider them good deals. Good deals to them are <80%

Agreed

they like sub 75s even better as indicated by their pricing for risk

Ta

rolf

 

[Peter_Tersteeg]

95% lends will only get you so far. You're automatically put into a higher risk category and there will be a point where you'll find your options drying up. Another con is with many lenders a 95% loan attracts a reasonably higher interest rate.

However, I think you'll find a lot of investors leverage above 80% for exactly the reasons you've indicated. I would suggest that 90% lends are far more sustainable, you can also get reasonable pricing and the LMI isn't as exorbitant compared to 95%. One of my clients is about to settle his 14th property and most of them are leveraged to 90%.

 

[TMNT]

95% lends will only get you so far. You're automatically put into a higher risk category and there will be a point where you'll find your options drying up. Another con is with many lenders a 95% loan attracts a reasonably higher interest rate.

so for someone with good servceiabilkity and enough cash, would you recommend doing as many 95%s as possible until they start saying no?

ive done 80% for all my properties, and in hindsight, thinking maybe I should have done them 95% on all of them, and for any new ones

 

[Aaron_C]

so for someone with good servceiabilkity and enough cash, would you recommend doing as many 95%s as possible until they start saying no?

The LMI premium is not worth it at 95% in my opinion. It actually doubles from 90% to 95%.

 

[tobe]

so for someone with good servceiabilkity and enough cash, would you recommend doing as many 95%s as possible until they start saying no?

ive done 80% for all my properties, and in hindsight, thinking maybe I should have done them 95% on all of them, and for any new ones

It depends....

If the purchase is under $300k and you have a lender who will capitalise LMI then 95% could be a good option if preserving your cash and maximum leverage is part of your strategy. Over $300k, the premium becomes more and more expensive. Some of the conversations I have with clients go something like this.

Is that $10,000 worth paying another $3000 in LMI? Even if the LMI is deductable, its a pretty hefty price to pay for money....

 

[Fifth]

There's also the psychological aspect. Starting with just 5% equity would make me feel a little too vulnerable. It isn't entirely logical, but it's something I can't shake off.

 

[devank]

There's also the psychological aspect. Starting with just 5% equity would make me feel a little too vulnerable. It isn't entirely logical, but it's something I can't shake off.

I also feel the same. No big deal even if the property prices drop by 10%!

I'm not sure how much you can really save once your include LMI and also higher interest rate payments.

 

[DaveM]

Some people I know buy at 95% with capped LMI, reno then reval to 90%.

Eg buy $250k (loan $237500), $10k reno, reval $300k new loan 90% $270k, releases about $35k for the next job.

 

[newbuilder2012]

IMO, never buy with 5% deposit to little.

20% or nothing, i rather have 3 on 20% then 10 on 5% deposit.

 

[Rolf Latham]

so for someone with good servceiabilkity and enough cash, would you recommend doing as many 95%s as possible until they start saying no?

ive done 80% for all my properties, and in hindsight, thinking maybe I should have done them 95% on all of them, and for any new ones

I will let PT come back with his views.

My experience with LMI and structured IP lending.......... go hard, go early, or go 80 %.

If all the ducks are lined up, you can get 90 % "ad infinitum" but ..........95s are damn hard once you already have a few under your belt, since the lender deemed serviceability may cause a major hassle

t
arolf

 

[Peter_Tersteeg]

so for someone with good servceiabilkity and enough cash, would you recommend doing as many 95%s as possible until they start saying no?

ive done 80% for all my properties, and in hindsight, thinking maybe I should have done them 95% on all of them, and for any new ones

My personal preference is to try keep things to 90%, but if you're cashed up and want an easier life, go with 80%. Arguments for staying at 90% or lower:

* Many lenders have their own underwriting authority. If you go over 90% the application usually goes to the mortgage insurer and has a significantly higher chance of rejection for stupid reasons like, "You're too rent reliant". Mortgage insurers also have their own internal limits on how much they'll allow you to borrow. Even if you mix it up across multiple lenders, applicantions can get rejected because the mortgage insurer sees all. Try having 4-5 properties and do a 95% lend and see what the mortgage insurer says.
* About 50% of lenders charge a significant interest rate premium as soon as you borrow more than 90%. Often upwards of 0.3% more.
* Most lenders won't allow you to refinance or top-up to more than 90% so you could be waiting for a long time to access your equity.
* LMI premiums jump significantly over 90%. For loans over $500k with Bank of Melbourne, the premium is over 4%. You end up gaining an extra 5% of the purchase price, only to pay almost half of this back in LMI premium.
* Many lenders won't allow you to capitalise LMI over 95% (but some do), so it's not 95% + LMI, but just a flat 95% and you come up with the LMI.
* Many lenders require you to have a prior debt with them or 20% equity in another property for them to allow you to lend more than 90%.
*Genuine savings is given far more weight.
* In my opinion, lenders look for reasons to reject loans over 90%. Below 90% they're more forgiving.

Don't get me wrong, if 95% is what gets you into the market then that's fine, but 90% or lower makes your life a lot easier.

 

[Aaron_C]

100% agree with what Peter has said. Every bank tells you they can go up to 95% but it's all the marketing - credit policy has the final say.

 

[Weasil007]

IMO, never buy with 5% deposit to little.

20% or nothing, i rather have 3 on 20% then 10 on 5% deposit.

Agree in full here. In an appreciating market 5% deposits work great. In a flat or depreciating market it is a recipe for disaster. The government should mandate min 20% deposit finance for property purchases. Good enough for SMSF's then why not for the rest of the population

 

[Rolf Latham]

Agree in full here. In an appreciating market 5% deposits work great. In a flat or depreciating market it is a recipe for disaster. The government should mandate min 20% deposit finance for property purchases. Good enough for SMSF's then why not for the rest of the population

Perhaps the gov should own the banks?

Ta

Rolf

 

[spludgey]

Agree in full here. In an appreciating market 5% deposits work great. In a flat or depreciating market it is a recipe for disaster. The government should mandate min 20% deposit finance for property purchases. Good enough for SMSF's then why not for the rest of the population

While having an antagonist certainly makes things more interesting, I do start to wonder why you post in this forum. I'm curious to know whether you own property yourself?

As for 5% deposits spelling disaster in a falling market, can you elaborate? Even if the house prices fell over 50% and the house value was half of the mortgage, what would be the big problem? Sure, it would be a little annoying, but I'd still be able to service the loan the same as before. While I can't predict which way house prices are going to go, I'm pretty certain that the only way rents are going to go is up.

 

[Weasil007]

Perhaps the gov should own the banks?

Ta

Rolf

Definatly NOT...
If the banks undertook prudent lending habits there would be no need to nationalise them and they continue as is