Warning: How Labor’s 5% deposit promise may also hurt first-home buyers

Labor’s pledge to help more first-home buyers enter the market by way of a 5% could also make things tougher for them.

The expanded scheme may make home ownership easier for many but also has its downsides, namely larger loans and potentially higher prices.

The Albanese government expanded its Home Guarantee Scheme to all first-time buyers last month by raising property price limits and eliminating caps on positions or income. The government will also secure a portion of the loan.

The Labor Party announced its proposal to allow 5% deposits in the lead up to the 2025 federal election. Picture: Getty

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The initiative saves first-home buyers from having to spend tens of thousands of dollars on Lenders’ Mortgage Insurance (LMI), which can be significant with a small deposit (a 5% deposit on a $1m property could cost around $50,000 in LMI).

The median value of a home in Australia is now $827,000 — a new record — according to PropTrack data. Purchasing a home of that cost with a 5% deposit means you’ll only need $41,350.

But the scheme doesn’t make things quite as simple as they sound. Here’s a look at the pros and cons of buying with a 5% deposit.

Pro: Getting in quicker

Melbourne-based Mortgage Choice broker David Thurmond says the Home Guarantee Scheme gives first-home buyers “a fantastic leg-up”.

While a 5% deposit could help buyers get into the market more quickly, there are potential repercussions down the line. Picture: Getty

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“I think it’s a brilliant scheme. It helps you get into the property market faster, and without paying lenders mortgage insurance. Rent is oftentimes more expensive than a mortgage right now, especially with interest rates coming down,” he says.

“And if you only have to put down a 5% deposit, that’s leaving you more of a savings buffer going forward, which gives you a really good starting point — and means you’re more likely to avoid financial issues down the track.”

Pro: Not needing a guarantor 

The Albanese government will guarantee a portion of a first-home buyer’s loan, which it says alleviates the financial burden on parents, who can use the money for their own retirements.

Mr Thurmond says having the government as your guarantor is preferable to relying on family.

“Rather than having anything impact your mum and dad, you can use the government as a guarantor instead, which is a much better position to be in.”

Curtin University professor John Curtin and Australian Research Council future fellow Rachel Ong ViforJ agreee the government’s involvement is good news for buyers.

“I would say the risks are minimal with Labor’s scheme since the government is the guarantor here.”

Con: Bigger loans

Buying with a 5% deposit means taking out a loan that covers 95% of the property’s value.

For many, this entails a substantial mortgage, especially in a market where reduced interest rates are increasing buyers’ borrowing capacity, thereby stimulating buyer interest, intensifying competition and driving home prices to new heights.

In May, the Reserve Bank of Australia lowered the cash rate to 3.85%, its lowest in two years, with future rate cuts anticipated this month.

“A large mortgage is a problem with a low 5% deposit,” Mr ViforJ explains. “It means the borrower must take out a loan that is 95% of the home value.”

Buying outside capitals in regional areas may be preferable for that reason, she suggests.

“In a major capital city like Sydney, this could mean loans approaching $1 million. In most regional areas, house prices are lower than capital cities, so loans will not be as sizable.”

Buyers should ensure they have a sufficient financial buffer in the event of rising interest rates or changes in personal circumstances, like job loss.

Australian lenders also have a responsibility to prevent borrowers from overextending. Since 2021, banks have had to apply a 3% serviceability buffer for mortgages, helping to ensure borrowers can continue repayments across various scenarios, including economic shocks and interest rate increases.

Ms ViforJ, says the serviceability buffer “will be helpful here”.

Mr Thurmond adds that if banks proceed with a 95% loan after factoring in the serviceability buffer, he feels confident too.

Experts say banks in Australia can be more conservative than other countries when it comes to lending. Picture: News Corp Australia

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“Banks in Australia are a lot more conservative than in many other countries, so if a client’s capable of making the repayments and this 5% allows them to get into the market more easily, I don’t see that as a great risk.”

Con: Higher potential for negative equity

A potential risk of a small deposit is having reduced equity, increasing the chance of falling into negative equity — where your home’s value drops below your outstanding loan balance.

Of course, this only really presents as a problem if you decide to sell.

“If you lose your job and can’t continue making mortgage repayments, you may have to sell the property. Having a low 5% deposit loan means that after you repay the home loan worth 95% of your property value, you may not have much equity left,” Ms ViforJ warns.

Buyers using the 5% scheme would have to beware of the exact risks of losing their property should they be unable to pay their mortgage. Picture: Getty

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But Mr Thurmond says negative equity is unlikely to be a concern in a rising market.

“How many times in the past 20 years have we been concerned about negative equity?”

If you can hold onto your home, equity is less important, he adds.

“As long as the client can afford the repayments, they wouldn’t have to sell the property at a loss.”

Con: Higher property prices

Enabling more first-home buyers to enter the market always has the potential to increase competition and drive up prices, which makes housing subsidies a delicate balancing act for any government.

“This is a major issue,” Ms ViforJ states. “This scheme has existed for several years, but so far places have been tightly capped, and strict income and property price limits have been applied.

“Now, many more aspiring first-home buyers will be eligible for the scheme, which will drive up demand.”

She expects the scheme to have an impact on property prices.

“With this scheme being expanded and further interest rate cuts expected in the coming months, I think we can expect to see house prices go up.”

This article first appeared on Mortgage Choice and has been republished with permission.