This month’s case study looks at a client that found themselves almost at the magical 20% deposit. Almost… but not quite.
Let’s call the couple Bill and Hillary (obviously not their real names!). Bill and Hillary had their offer accepted on a property at $550,000. Once their deposit was tallied up, they discovered they had a 19.7% deposit. This meant they were $1,602 short of the ideal 20% deposit.
As our regular readers will know, it is entirely possible to purchase a house with less than 20% but the costs become significantly higher. Low equity buyers either pay a one-off fee or have additional amounts added to their interest rate. For Bill and Hillary, this amounts to 0.25% of the total mortgage (either as a fee or as additional interest rates).
Probably the easiest way to see the difference in cost is in the table below. The first column shows the total cost of borrowing if the deposit remains at 19.7%. The second is the total cost for an “ideal” 20% deposit.
|Indicative Interest (1 year fixed)||4.99%||4.19%|
|Low Equity cost (either interest or fee)||0.25%|
|Total paid year one||23,140||18,436|
Bill and Hillary are going to have to pay an extra $4,704 in interest and/or fees because they are short on their deposit by $1,602. This is a lot and amounts to the equivalent of 293% annual interest on the $1,602. There are much cheaper forms of funding…
Actually almost every other form of funding in the world would be cheaper!
The most obvious solution seems to be to borrow this money from another source. This is actually not a good solution. The banks don't like it when you borrow your deposit, even if a Credit Card at 20% interest rate is a much better option than 293%. If the bank sees this withdrawal, it will count as a red mark against the application.
It is possible that close family may be able to loan or gift Bill and Hillary the money. As long as this is declared in the form of a Gift Certificate, it is a perfectly reasonable solution to the problem.
It may be that the full 20% deposit will be available after the next pay cycle. Banks typically like the deposit to be physically in the bank, however a good explanation around this may make it a viable solution.
The reason, I am not such a fan of this third solution is that there will be additional costs to do with purchasing (moving costs, lawyer, possibly a Valuation) and we have used up every single last cent of their savings... even the next pay cycle's savings. This could cause the couple stress if settlement day is within a month or so.
Our preference is Solution 2 followed by Solution 3, if necessary. We can structure the mortgage payments to quickly pay back the loan from family and it saves the client nearly $5,000 in additional costs. It also gives the couple some spare cash for the additional cost that comes with purchasing. If they don't have family with that kind of spare money, Solution 3 is the next most viable option.
It would have been easy for these clients to have been caught out by the shortfall but with a few quick calculations, a lot of money can be saved.
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