Those who purchase with a small deposit could end up owing thousands more than their home is worth
First-home buyers who purchase with a small deposit could end up owing thousands of dollars more than their home is worth if property prices fall, new data shows.
Many first-home buyers now have a bigger budget to work with after the federal government lifted the price caps for the Home Loan Guarantee Scheme this week, according to a report by The Sydney Morning Herald. The program allows buyers to purchase a home with a 5% deposit without paying lenders’ mortgage insurance.
But the boost comes as price growth begins to slow after a pandemic-driven housing boom. Economists expect prices to drop as interest rates rise and reduce the amount buyers can borrow.
According to Canstar modeling, that could leave some buyers owing more than their home is worth.
For example, a Sydney buyer could put down a $45,000 deposit for a $900,000 home under the scheme. If prices fall in line with predictions by National Australia Bank – down by 10% by the end of 2023 – the buyer’s home would be worth $808,740.
But after taking out an $855,000 mortgage and making regular repayments, the buyer would owe $830,534, the Herald reported. That would mean they owe $21,794 more than the value of their home – putting them in negative equity.
A Melbourne buyer with a $40,000 deposit on an $800,000 home could see their home’s value fall to $715,200 by the end of 2023. However, their loan balance would be $738,252, according to the Herald – $23,052 more than their home is worth.
In smaller capital cities where price drops are forecast to be less severe, new homeowners could remain in positive equity, the Herald reported.
Negative equity isn’t an issue for homeowners who remain in their homes. But it can become a problem for those who need to sell suddenly, want to refinance, or have financial troubles that make it difficult to pay their mortgage.
Read next: Economists issue warning on guarantee scheme changes
Steve Mickenbecker, group executive for financial services at Canstar, said highly indebted borrowers in Sydney and Melbourne are especially at risk of negative equity if property prices drop. He told the Herald that while there is no issue for someone who intends to keep living in their home, those who need to sell quickly could find themselves in trouble.
“Not only have they lost the money they put in, but when they sell they’ll have to find extra cash to repay the loan,” Mickenbecker said.
RateCity research director Sally Tindall told the Herald that homeowners with low or negative equity might also find it difficult to refinance until they build up 20% equity, as many banks would be unwilling to take the risk.
Previously, first-home buyers under the government scheme would have hit that threshold rapidly thanks to skyrocketing home prices, allowing them to remove the guarantee.
“For first-home buyers that managed to take it out up to this point, in some cases they’d probably be laughing all the way to the bank,” Tindall told the Herald. “The downside of this type of scheme is you’re taking out a larger loan. Your monthly repayments will be higher. When interest rates rise, the pain of those interest rates will be magnified with a larger loan.”
