Should You Use a Big or Small Deposit When Buying a Property?
Should you use a big deposit of 20%+ when investing in property or a smaller deposit of around 5 or 10%? There are pros and cons to each which we look at in today’s episode.
0:00 – Introduction
0:39 – What everyone else says you should do
1:25 – The 4 major considerations
1:56 – 1. Lenders Mortgage Insurance
3:51 – 2. Market Timing (Getting Into The Market Sooner)
5:35 – 3. Risk Profile
8:15 – 4. Cashflow
11:33 – It’s not a clear cut decision
12:46 – What is your strategy/end goal?
let’s talk deposits when you’re investing in a property should you use a big deposit of 20% or more so you don’t have to pay lenders mortgage insurance or should use a smaller deposit somewhere around 5% or 10% so that you can get into the market quicker and maybe expand your property portfolio quicker as well different people say different things but it’s ultimately up to you to assess what’s going to be best for your situation and your risk profile so in this video we’re going to be talking about big deposits for a small deposit what are the pros and cons of each so hey i’m ryan from onproperty helping you and your journey to financial freedom and as definitely people out there that are like no matter what the circumstances you should always use a 20% deposit to avoid lenders mortgage insurance so you don’t have to pay that and so i understand that that that makes a lot of sense and we will talk about that more but then you’ve got people on the other side that say you should use the smallest deposit possible so that you’ve then got more money to invest in properties also you can get into the market quicker and get capital growth faster and so we’ll talk about that as well but i’m just seeing people out there and say you should definitely do this or you should definitely do this no you should definitely do anything ultimately it comes down to you and everyone’s goals and everyone’s risk profiles and what everyone wants to do is different so in this video we’re going to be talking about some of the different pros and cons of each and so you can actually look at yourself assess yourself and decide okay where do i sit on the spectrum and what do i want to do so let’s look at some of the major things so the major things we’re going to look at firstly going to be lenders mortgage insurance and talk about that because that can be a big cost we’re going to talk about cash flow and how the size of your deposit affects your cash flow we’re also going to talk about timing the market and we’re gonna talk about your risk profile as well so let’s start by talking about lenders mortgage insurance now i’ve done a full video on exactly what this is a couple of years back so i’ll link up to that down below but really simply this is insurance that if you don’t have a large enough deposit and usually that’s 20% on residential property investments if you don’t have that large amount of margin off deposit the banks are taking an extra risk giving you a loan and they want insurance to cover that risk in case you have to sell the property and the markets going down and they lose money just to put a disclaimer out there i’m not a mortgage broker or insurance broker but they they charge you this insurance and that’s an extra fee that you have to pay either for paid upfront or often it’s added on to your loan and so that’s an extra fee that you paid to the banks and ensures them against the extra risk they’re taking on us then the insurance isn’t necessarily for you it’s for them so a lot of people see that as a last costs or something that you have to pay that you don’t really see any major benefit from so this is why people often recommend that you save at least a 20% deposit i know with building granny flats you might need as much as 30% deposit the same with commercial properties if you’re going into rural markets and that can change as well so talk to your bank or mortgage broker about exactly how much you need now i did do i did quickly look online about how much you would have to pay but it can get quite expensive okay so on a $500,000 loan if you have a 20% deposit then you pay $0 in lenders mortgage insurance if you only had a 10% deposit this calculator estimated you’d pay $8.8 thousand or $8,800 and if you only had a 5% deposit then you would have to pay 17 and a half $1,000 in insurance so obviously this is a lot of money that you have to pay and so this is why some people recommend that you go with wait till you can say about the full 20% and avoid this cost so that’s one thing to think about but then the flip side of that is if you’re able to use a smaller deposit of 5% 10% you don’t have to save as much money you can often get into the market sooner so let’s use an example of a $500,000 property if you were to save a 20% deposit that’s $100,000 that you would need to save i don’t know about you but saving $100,000 that’s a daunting task and that would take a long time but how about if you can only save a 10% deposit and save 50,000 or 5% deposit and they have to save 25,000 there you have 50,000 or $75,000 that you don’t need to save how long is it going to take you to save that extra $50,000 you’re taking an extra year an extra two years and what’s going to happen to the market in that time if you’re looking at a $500,000 property let’s say it takes you two years to save that extra 10% let’s say the market goes up 10% in that time or goes up even more than that in that time that $500,000 property is now $550,000 in order to get that same sort of property so you kind of lost out on the growth in the market there so some people argue using a small deposit allows you to get into the market faster, which allows you to take advantage of market opportunities. Now at the moment, we’re going through a recession, and in some markets, that can actually be a really good opportunity to get in towards the bottom of the market. And to secure a really good property for a really good price before the market grows as the economy recovers from this recession, and from the buyers and everything like that. So there are arguments that that could be better. So you need to assess that for yourself, do you want to avoid that insurance? Do you want to get into the market sooner, and then you also have to look at your risk profile, as well. So getting into the market sooner, that could be good. But that’s going to expose you to more risk because you now have a small deposit, which means you have less equity in the property. So let’s say using a 5% deposit, you’ve got 5% equity, or maybe even less after you add the Lenders Mortgage Insurance to the loan, you might have a 3% equity or something in the property. Now, if the market was to go down by five or 10%, very quickly, you’re in a negative equity situation, where if you are forced to sell that property, you will actually lose money on that property. And you would not be able to pay off the full amount of your loan from the sale proceeds of the property, which means you’d sell the properties still have a chunk of debt leftover. So being in a negative equity situation, obviously, not very desirable. If you’ve got 10%, then you’ve got a bit more wiggle room there. But if you’ve got that full 20%, then you’ve got a lot more wiggle room to work with looking at when the market peaked in 2017 in Sydney, and Melbourne. And then we saw the declines in those markets in 2018, down to mid 2019, we saw about a 15% drop in those markets. Now, some suburbs dropped more, some suburbs dropped less than that. But 15%, if you were to invest with a 20% deposit, and you’re forced to sell your property, you still wouldn’t be in a negative equity situation. And we’ve got ash falling from the sky at the moment, because they’re doing some backpacking around here in the National Park hopefully to avoid the bushfires that we saw earlier in the year. But it feels like back in bushfire season when ash was falling down there. So you got to look at your risk profile. And what you think’s going to happen. Now, obviously, at the current stage of the market, the current stage of the economy is probably riskier than other times when we just clearly come out of a recession. And we’re in boom times ahead and lending law super favorable. So right now we’re in a turbulent time where it’s unclear exactly what’s going to happen in the market. And I have done an update video on where I think the markets going by looking at the data at the moment. So I’ll link up to that down below as well if you want to say, okay, what’s the data telling us what what are riskier areas than others? I’ll link to that down below. So you need to look at your risk profile there. So it talks about Lenders Mortgage Insurance and avoiding that or having to pay that. And obviously, the benefit of having a smaller deposit means you can potentially get into the market earlier. So I guess there’s pros and cons to both of those, that then increases your risk profile if you use a lower deposit. Because if the market drops, you’re faster, you’re going to go into negative equity faster. And then the last thing to think about is cash flow, and how this is going to affect your cash flow situation. Because if you’re using a larger deposit, then you’re going to have a lower mortgage on the property. So let’s use our real basic example of a $500,000 property. If we’re using a 20% deposit or putting down $100,000. Let’s just assume that, you know, we’re paying for all their extra expenses like stamp duty and stuff, real basic example not financial mortgage advice here, or accurate, but it’ll give you an idea.
That means 500,000 minus a deposit of 100,000. That’s $400,000. And so we’re then going to have to pay interest on that $400,000.
let’s say you only use a 10% deposit, so you’re putting down $50,000. So now you got a mortgage of 450,000 instead of 400. So that’s an extra $50,000 of debt that you now have to pay interest on. Now interest rates is super low at the moment, you’re looking around 3%, I heard this people getting interest rates under 3%. At the moment, which is insane. at looking at interest rates at 3%. That’s an extra 15 $100 a year in interest, you’d have to pay on $50,000. And that’s just interest only if you’re going to principal and interest then you will be committed to pay more per year by 15 $100. That’s about $125 per month. So that’s not too bad. But obviously if you’re looking at a million dollar property, then you could double that to $250 a month. And then if you look at something of more historical interest rate values of around 7%, then that 1500 per year jumps up to 3500 per year or $291 per month. So nearly $300 per month extra, you’d have to pay. Now obviously, if you do multiple properties, or if you have a million dollar property, you can double that, as you can start to see that it can really affect your cash flow $300 a month, $600 a month, it can get quite expensive. And then you need to pay that either out of the rent, or out of your own pocket, if you’re negatively geared. So it can affect your cash flow as well. So it’s very important to do your cash flow calculations on this, and on how a different deposit will affect your cash flow, I have created a tool called property tools.com.au, I created it years ago. So it’s a bit of an old tool, but you can still use it. It is a paid tool that you can subscribe to, but it’s pretty cheap. I’ll link to that down below. And that basically allows you to go through and do these calculations really quickly. So you put in the property price, you put in the rental income for the property, you put in the percentage of a deposit, as well as you can play with the interest rates. And you can just play with all these figures and say, Okay, how is this going to change my weekly or my annual cash flow based on if interest rates go up? Or based on if I use a lower deposit or a bigger deposit? And so you can play with that. And you can see, okay, where is my middle ground? Where am I positive cash flow? Where am I neutral? Where am I negative? And how negative am I okay to go. And so that’s a really cool tool. Again, property tools.com.au, if you want to go ahead and check that out. So should you use a big or a small deposit. Hopefully, if you’ve listened to this far into the episode, you can tell that it’s not clear cut, it’s not you should always use a big deposit. Because using a bank deposit might mean that it takes you an extra couple of years to get into the market, which means you could miss out on a lot of growth. A lot can happen in those couple of years as well, where things could happen in your life where that money then needs to be directed and used for something else. Maybe it could be medical, or maybe your car breaks down or there’s a myriad of things that can come up in life, you might, again be difficult to leave that money there when you could go on a holiday or you could buy your favorite car that you’ve always wanted. So life can get in the way as well. So you can save that Lenders Mortgage Insurance, but it takes you longer to save it, which might mean you never invest at all. So is it better to invest in to take the higher risk pay the Lenders Mortgage Insurance, you may get market timing there and get a couple of years of growth. But it also kind of locks you into buying a property. Whereas if you waited, you may never actually do it. But by locking it in, you’ve committed to that path now. And you’re kind of building up that foundation for yourself. So there’s obviously those sorts of things, then you got to consider the risk profile, you got to consider the cashflow effects. And ultimately it comes down to you. And it comes down to what suits you best. And also, what’s your strategy? What is your end goal? For all of this? What is your vision for your property portfolio and your financial future? What are you striving towards? And hopefully you’ve you’ve worked that out. And if you’ve watched enough of my videos, you know, I’m so big on strategy, having that clear strategy just makes it so easy to invest, and so easy to make those decisions. And I was so happy to log on today and to see a video from Pumped on Property, who’s a buyer’s agency that I work really closely with. So Ben has actually I remember I was sitting down with Ben in February talking about his position, what’s he going to do? Is he going to buy more properties is he going to save and you know, I, I sometimes act, I act as a bouncing board for him. Because I’m one of the few people that he trusts in that area, which is really cool. It’s great to be a part of his life. But long story short, to see a video of him saying here’s what I bought. And just to be perfectly aligned with his strategy, he has bounced around so much. And now he’s got this clear strategy of how many properties he wants to own each of them being Julie income, and then eventually pay them off. And so he’s purchased this bomb of a property in the worst condition ever. But he’s going to knock it down, he’s going to build a jewel occupancy property on that which is perfect for him. And perfect play to his strengths, and what he needs out of a property. And so he’s doing that, which is going to lead to long term success for him. He’ll have a dual income property that’s failing, you be completely paid off, and just have that income coming in. It’s like, I see that on my fan. Finally, you’re following your strategy, and you’re finding what works for you and what’s going to line up with you long term. It’s not super exciting. It’s not super risky. It’s pretty low risk for him, but to just see him on that path. And so your strategy will play into how big of a deposit Do you need as well. And if you need help with your strategy, then done a video on the two year strategy that how you can set yourself up for financial freedom in just two years ago, I did a video with Ben on that. I’ll link up to that down below. Or if you actually want to talk to someone and say, Okay, here’s where I’m at right now. I don’t really know where I want to go or maybe Okay, here’s why. i want to be financially free or i want to own this amount of properties in the future but you can actually talk to someone who’s a specialist in this area then head over to onproperty com au forward slash strategy and you can read all about it over there but you can book in a strategy session with a time that suits you there’s a calendar over there you can put in your time and it’s just it’s a fun conversation to go through on all of this get clear on where you’re at get clear on where you want to be and get clear on a strategy to get you there and funnily enough like once you know where you are where you want to be what your strategy is then how much of a deposit you want to put down kind of solves itself and that becomes really clear to you and to your situation and so that’s a really great resource again go to onproperty com au forward slash strategy
to go ahead and check that one out it’s been so helpful to so many people and so i thank the buyer’s agency pumped on property for offering that but yeah are you going to use a big deposit are you going to use a small deposit ultimately it comes down to you what your needs are and how you want to invest so i wish you the absolute best out there in your property journey don’t forget to enjoy the journey don’t forget to have fun along the way enjoy saving enjoy that process enjoy investing and make your life awesome at the same time so thanks so much for tuning in today i’ll link up to the two year strategy over here i’ll also link out to how to enjoy saving money so that you can enjoy the process of saving your deposit check them out otherwise until next time stay positive