Why LMI isn't just for first home buyers
6 min read
You may think that low deposit home loans are specifically designed with first home buyers in mind. But, did you know that second home buyers can significantly benefit from taking out LMI?
Maybe you're eyeing off a heavenly holiday home on the coast, or an investment property to grow and diversify your portfolio. Regardless of your motive, purchasing a second property can be a positive move for your financial future and the cost of owning another home can be surprisingly manageable, even with the perceived cost of LMI (should you decide it's the right option for you). If you can move fast and capitalise on (fingers crossed) house price growth, the ability to take out LMI may support you in achieving your investment goals sooner.
Think of it this way. Saving for a deposit is hard, and it can take years. By the time you've saved up 20% for the cute cottage on the corner, the price has jumped 25% and you need to save even more, lest you retire your inner-city dreams and build fresh on the city outskirts.
With median house prices in Australia hovering around $800,000, saving a 20% deposit of $160,000 can be daunting especially in an unpredictable housing market.
In an environment where house prices in most states are either steadying or steadily rising, Tic:Toc's low-deposit option can get you into a property with as little as a 10% deposit (plus all the bonuses that come from our high-tech platform - like our super low rates).
Purchasing a property typically requires you to come up with a 20% deposit. Regardless of whether this is your first, second or third property, you'll have to make some kind of contribution (your deposit) towards the home, which can comprise of savings, equity from another property you own, grants, or a little help from your parents or family. One of the largest hurdles associated with purchasing a second property is that it requires a large amount of money upfront, which may be difficult given you're already juggling home loan repayments (or rent!), as well as the rising cost of living and slow-to-grow household incomes. But I digress. Give yourself a little leg up and consider using LMI to make up a portion of your deposit.
If you're purchasing a second home to live in, or to grow your investment portfolio, using LMI can help you to achieve this goal much earlier by enabling you to get in with a lower deposit.
For investors, timing is critical. Most investors rely on future savings and equity to grow their portfolio. Waiting to save a 20% deposit before each property purchase could significantly delay the investment, pushing out the eventual investment goals and potential savings. LMI gets your money working for you sooner as a way of purchasing your property and benefiting from long-term investment holdings.
To help illustrate the point, we've charted the projected value of a home over a 10-year period against the amount required for a 20% and 10% deposit, as well as the projected increase in property value and yearly savings.
We're using two key assumptions based on CoreLogic data. The first is the 2018 national median house price of $517,441. The second is the national median house price growth rate from 1993-2018, which is 6.8% p.a.
Imagine. It's January 1st, you have $0 in savings and you've decided to start saving for a $571,441 house. Yes, that exact amount, because you like to be specific. Assuming steady house price growth of 6.8% p.a., and providing you can save $30,000 per year, you will be able to afford such a property (excluding government and other costs) with a 20% deposit in roughly 5 years. Or, by utilising LMI to purchase with a 10% deposit, you could save time and acquire the property in approximately 2.2 years.
In this scenario, the property value jumps by $835,000 over the period. A decent return on investment. In the same 10-year period, you could instead save a total of $300,000 in pure cash. The sooner you purchase a house, the sooner you have access to the potential property capital gains. But you never know. The housing market is fickle. Growth could stall or go backwards or skyrocket. Our example is for a very specific scenario to illustrate how LMI may help. Your situation could be different from our illustration and should not be relied on as financial advice. Always seek financial advice from a professional in relation to your specific circumstances.
While minimising your borrowing costs may be a priority for you, the cost of LMI may be worth incurring. The oft-forgotten cost of missing out on a prime opportunity of a rare investment or your dream property because you don’t have the required upfront costs could be much greater over time when compared to the one-off LMI cost that you may incur upfront. Don’t underestimate the power of opportunity. No Ragrets (not even one letter…!).
For investors, LMI is deductible if the loan relates to an investment property purchase. According to Section 25.25 of the Income Tax Assessment Act 1997 (sorry for getting technical), you can deduct expenditure you incur for borrowing money, to the extent that you use the money for the purpose of producing assessable income. Food for thought! Tax benefits should not be overlooked.
Taking out LMI can also allow property investors to have higher borrowing ratios, providing the opportunity to leverage the possible benefits of negative gearing. Negative gearing, put simply, is when you borrow money to buy an investment, but that property loses more money than it makes on a regular basis – sounds like a bad thing right? Don’t be fooled! While negative gearing does allow for short term gain too, the key advantage lies in the long-term financial boost when the value of the negatively geared property jumps providing great potential for capital growth.
For example, a person making $80,000 per year might purchase an investment property with LMI. Expenses on the property are $100 per week, and repayments on the loan are $350 per week. The property generates income of only $400 per week, meaning $50 per week ($2600 per year) is lost, and therefore the house is negatively geared. The annual loss of $2600 can be used to reduce taxable income and can form part of a tax minimisation strategy. The upshot of negative gearing is the opportunity for the investment property’s market value to increase over time, which can recoup (in some cases, significantly) the sustained losses.
So, taking out LMI for your investment property can be a positive step to help you achieve a long-term financial goal.
It’s important to consider LMI for not only your first home but your second and investment properties too! Read more on LMI and consider whether you should keep saving or take up LMI.