What you should know before you apply for the budget’s First Home Guarantee

With booming housing prices across the country, getting onto the property ladder — and especially saving for a deposit — can seem impossible.

This year’s budget includes millions of dollars to expand home loan guarantee schemes to 50,000 places a year, with the aim of helping more people get into the housing market sooner.

The schemes allow mainly first home buyers to get a mortgage with a low deposit of between 5 per cent and 20 per cent of the value of the property.

One scheme for single parents requires only a 2 per cent minimum deposit.

Loans with deposits of less than 20 per cent are seen as risky by financial institutions, making it harder and more expensive to get a home loan.

Under the schemes, the government guarantees part of the mortgage, which means borrowers don’t have to pay costly lenders mortgage insurance, which protects the bank if you default and can’t pay your loan.

So what are the pros and cons?

How does it work?

First home buyers can apply for a loan with a deposit of as little as 5 per cent of the property’s value and single parents can apply with a deposit of just 2 per cent to buy a first home or re-enter the property market.

There is also a new scheme to help people buy or build homes in regional areas.

You apply for the scheme through a participating lender, so not every bank can offer the loans.

And you need to show proof of your deposit.

There are caps on the value of homes that can be purchased under the government guarantee schemes.(ABC News: John Gunn)

Income and property price caps

There are income limits and limits on the value of the property that you can get the loan for.

The scheme is capped at $125,000 annual income for individuals and less than $200,000 a year for a couple.

You must be an owner-occupier and the term of the loan is limited to 30 years.

And you must pay back both principal and interest on the loan.

Also, the value of the property must be within the limit for the suburb and postcode where you are buying.

For example, New South Wales limits the property value to $800,000 for capital cities and regional centres, while the cap is $600,000 in regional areas.

In Perth and Hobart, property prices are capped at $500,000.

A table showing property price caps for the Home Guarantee Scheme
Property price caps for the Home Guarantee Scheme. (National Housing Finance and Investment Corporation (Supplied)

Interest rates can be higher

Because low deposit loans have what’s known as a high loan to value ratio (LVR) they are seen as more risky by the banks.

Home loan comparison website RateCity says that means that some banks charge a higher interest rate for borrowers on the scheme compared to their discount variable mortgage rates, because they think you have a bigger chance of defaulting on your loan.

RateCity research director Sally Tindall says it’s also because a limited number of financial institutions are involved in this scheme.

For example, two of the four major banks currently charge borrowers with an LVR above 80 per cent a rate of 2.99 per cent compared to the lowest discount variable rate of 2.19 per cent, a 0.8 per cent difference.

Ms Tindall says some smaller lenders, such as mutual banks and credit unions, are offering rates as low as 2.14 per cent, so it pays to shop around.

There is a consensus among economists that interest rates will rise, almost certainly sometime this year, with the only argument being when they will start going up and how high they will get.

“”Buying with a 5 per cent deposit means a person’s loan size is significantly larger than if they had bought with a 20 per cent deposit,” Ms Tindall cautions.

What about property prices?

Ms Tindall agrees with several housing analysts who say there’s a risk that the government subsidy could initially further boost housing prices.

Sally Tindall, RateCity
RateCity director of research Sally Tindall says low levels of equity make it very hard to refinance a loan and change lender.(ABC News: Daniel Irvine )

“Over the last year, according to the ABS data, we’ve seen the biggest annual rise in property prices [on record] of 23.7 per cent.”

Property research firm CoreLogic has said the expansion of the scheme could drive up prices at the low end of the market because more people will be able to buy homes.

“I think it could benefit first-time buyers who come into the market before prices potentially could surge as a result of the scheme,” says property data supplier and forecaster Louis Christopher, who runs SQM Research.

The scheme started small in 2020 with 10,000 borrowers, and the expansion to a total of 50,000 places will potentially significantly drive up demand for certain types of properties in certain areas.

Negative equity risk

Then there is the other house price risk — that despite the boost to first home buyer demand from the scheme, other factors mean property values ​​start falling.

Negative equity is when the value of your property falls below the amount that you’ve borrowed.

This is a big risk, according to Ms Tindall and Mr Christopher.

They are both concerned that higher interest rates may cause property prices to fall later in the year, and Mr Christopher warns that could leave many people who use the scheme in a tricky financial position.

RateCity has crunched the numbers using Westpac’s interest rate and property price forecasts and warns negative equity is a real risk for first home buyers and single parents who use the scheme.

a table showing negative equity for borrowers if interest rates rise
RateCity says buyers in the Home Guarantee Scheme may see their equity fall if interest rates rise and their monthly mortgage repayments increase. (RateCity (Supplied))

Ms Tindall says both the government and the opposition are encouraging people to get further into debt, despite regulators like the Reserve Bank’s Dr Philip Lowe telling borrowers they need “buffers.”

“Encouraging people to buy at inflated prices with next to no buffer in the face of rising interest rates comes with some pretty serious risks,” she warns.

Ms Tindall also warns that low or negative equity means borrowers will find it difficult to refinance their loans to get a better deal.

“If property prices then drop, people using this scheme are also likely to be locked into their lender and their guarantor for longer.”

LMI could rise

The Insurance Council of Australia warns the extension of the scheme could also have “unintended consequences”, such as causing lenders mortgage insurance (LMI) premiums to be increased for other home loan borrowers who are not using the government schemes.

Chief executive Andrew Hall thinks that could hurt smaller and medium-sized lenders and lower competition in the marketplace.

He says LMI gives people with small deposits the opportunity to get into the housing market sooner because they don’t have to save up for a larger deposit, but their loans are seen by financial institutions as more risky.

“You’d naturally assume that because they only have 5 per cent of a deposit to get into a home that they would present a higher risk,” he explains.

Who’s used the guarantees so far?

Nearly 60,000 mainly first home buyers since January 1, 2020.

Government figures show one in five guarantees have been issued to essential workers. Out of that group, just over a third were nurses and another third were teachers.

Women received 52 per cent of the guarantees and 85 per cent of family home guarantees went to single mothers.

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