The 5% home deposit risk no one is talking about

3 days ago 6

Wednesday last week marked the start of a charge for the expanded, expedited 5 per cent property deposit scheme. But I have an important warning: don’t join the throng unless you’re sure your 95 per cent loan will be approved.

This is the risk no one is talking about with a 5 per cent loan application: get rejected and not just your heart, but your credit score will sink. And so too will your chances of getting approved the next time.

Affording a property just became a lot easier, but make sure you do this before you apply.

But a couple of key steps make approval more likely. So, what’s the opportunity, and how do you safely take advantage of it?

In a Hail Mary for the housing market, roughly six weeks ago the government brought forward by three months the planned removal of the income test for eligibility for the First Home Guarantee, and the increase in the property price thresholds.

However, if you haven’t been prepping for your application since before that announcement, despite the enhanced scheme’s early start, you’re not yet ready. Let me explain.

The previous price caps were extremely restrictive, based as they were on average property prices. Apartment values dragged down this average, making many houses out of reach. The revised caps are the average house price.

If you don’t take these steps before you apply for a loan, you may well get refused.

And you can now – theoretically – borrow much more. In reality, it’s tough getting a loan over the line, especially a large one.

In Melbourne, the price cap is now $950,000, in Brisbane it is $1 million and in Perth it is $850,000. In Sydney, the cap has been supercharged, with first homebuyers now able to purchase a property worth up to $1.5 million as of October 1.

A 95 per cent loan on that is $1,425,000. Yes – that much. You can basically forget about it unless you are a dual-income household. And it will probably be a serviceability stretch regardless.

As the government’s first home buyers website says: “You must also meet your participating lender’s credit policy and loan approval criteria. Even if you are eligible for the scheme, you may not get a home loan if you do not meet the lending requirements of your participating lender.”

In any case, and in any place, there are three vital preparatory steps to giving yourself the best chance of getting a mortgage approved. These are:

Step 1: Sort your credit score. You need to check your credit score and credit record before applying. This must be at least “average” but “good” or above is better. You can obtain a free copy of your report and score with Illion, Equifax and Experian four times a year.

If yours falls short (each bureau bizarrely has a different score scale, but it will be clear how good yours is), look for errors on your credit report and reach out to the provider and then the credit bureau to correct them.

Step 2: Curb your card limits. Most people do not realise that credit card limits wipe a significant amount from the amount you can borrow. And this is even if they are unused, or you clear your card in full every month.

The thinking is that you could run up your credit the moment your loan comes through. And you could.

In fact, you rule out about seven times what you have in latent card limits, from the amount of a home loan. So a $10,000 total card limit will lose you $70,000 of a loan. It may be worth reducing or even culling these cards for the application process.

Step 3: ‘HEM’ your spend. The third so-important precursor to applying for a loan – and the one for which you need that three months up your sleeve – is the so-called Netflix test.

Ditch any discretionary spending that you can… we are talking streaming services, subscriptions, ride-share services, expensive beauty creams/treatments, and dinners or entertainment out. It’s only for three months.

Because a prospective lender will forensically assess your finances for how much you have spent over the last quarter and from that determine how much budgetary buffer you have for mortgage repayments.

Borrowers will be sure to check your loan eligiblity carefully.

And remember it won’t calculate this on current interest rates, it will do it plus 300-basis points – the stress test. That means you have to prove you have a lot more financial capacity than you actually need.

Just be aware of taking a razor too deep to your spending, though – a lender could use the higher of your actual costs or a guesstimate known as the household expenditure measure or HEM.

But if you don’t take all of the above three steps before you apply for a loan, you may well get refused. Don’t risk your credit score – vital for lending approval at any time – by leaping in before you will enjoy success.

Nicole Pedersen-McKinnon is the author of How to Get Mortgage-Free Like Me, available at www.nicolessmartmoney.com. Follow Nicole on Facebook, X and Instagram.

Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

Get workplace news, advice and perspectives to help make your job work for you. Sign up for our weekly Thank God it’s Monday newsletter.