25/6/2022
The ongoing discussion around housing affordability in Australia often leads me to think about what can be done to make housing more accessible to the general population; and, in particular, first home buyers. As a result, I started reading about the government’s First Home Loan Deposit Scheme (FHLD), which is designed to reduce the upfront costs for first home buyers, thereby helping them purchase a property sooner.
What is the First Home Loan Deposit Scheme?
Typically, purchasing a home requires a deposit of at least 20% of the value of the home. If a buyer isn’t willing/or able to meet this requirement, they can use smaller deposit and purchase lender’s mortgage insurance. It should be noted that LMI can cost tens of thousands of dollars and is purchased by the buyer to protect the lending institution in the event where the buyer is unable to make repayments. Under the First Home Loan Deposit Scheme, the government will provide a guarantee for up to 15% of the value of the property which allows eligible first home buyers to use a smaller deposit without the need to purchase lender’s mortgage insurance (NHFIC 2022)
The First Home Loan deposit scheme was capped at the 10,000 places for the 2021-2022 financial year but will be extended to 35,000 places for this financial year (NHFIC 2022). The property price thresholds vary between states and postcodes and they appear to be set such that first home buyers need to look at properties under the median value.
How is it supposed to help first home buyers?
Since the government guarantees the value of the property, there is no need to purchase lender’s mortgage insurance; this allows first home buyers to purchase a home using a smaller upfront payment. For example, the typical upfront costs of buying an $800,000 property would either be a $160,000 (20%) deposit; or ~$70,000 ($40,000 (5% deposit) + ~$31,393 LMI) (Your mortgage 2021). Using the first home loan deposit scheme a first home buyer would only need to save a minimum of 5%, which equates to $40,000, to purchase the home. It should be noted that in all cases stamp duty is required to be paid upfront.
Considering other financial impacts
On face value, getting into a home sooner seems beneficial, however, it means that the first home buyer must use additional leverage. Some of the consequences this may have on a household’s finances include:
- Increased cost of living through increased interest repayments
- Increased exposure to interest rate movements
- If home ownership is a goal – an increased payback period
To illustrate these impacts, let’s take a look at 2 types of households which are both earning the maximum allowable taxable income and are looking to buy an $800,000 property (maximum for NSW capital city or regional center) (NHFIC 2021).
Single income household
In order to be eligible for the scheme a single income applicant can earn a maximum of $125,000 pretax. After paying tax of $31,317.00 and Medicare levy $2,500 (ATO 2022) this equates to a disposable income of: $91,183 p.a. or $7,598.58 per month.
Dual income household
Couples can have a maximum combined income of $200,000 pre-tax and be eligible for the scheme. For, modelling purposes I’ve assumed that each party has an income of $100,000. This implies that individually they liable for $22,967.00 tax and a Medicare levy $2,000 (ATO 2022) After taxes and the Medicare levy is removed their total household income equates to $159,066 p.a. or $13,256 per month.
Results
Saving for the initial upfront payment
Table 1 shows the time it would take for each of the households to save the required upfront payments (excluding stamp duty) to purchase an $800,000 home at different savings rates. For all cases I have assumed that the interest on a savings account is 2% (ING 2022).
| Single | |||
| $160,000 deposit (20%, no LMI) | $40,000 deposit (5%) + $31,393 LMI | $40,000 deposit (5%) + No LMI | |
| 30% of take home income $2,280 per month | 67 | 31 | 18 |
| 40% of take home income $3,040 per month | 51 | 24 | 14 |
| 50% of take home income $3,800 per month | 41 | 19 | 11 |
| 60% of take home income $4,560 per month | 35 | 16 | 9 |
| 70% of take home income $5,320 per month | 30 | 14 | 8 |
| Couple | |||
| 30% of take home income $3,977 per month | 39 | 18 | 10 |
| 40% of take home income $5,303 per month | 30 | 14 | 8 |
| 50% of take home income $6,628 per month | 24 | 11 | 7 |
| 60% of take home income $7,954 per month | 20 | 9 | 6 |
| 70% of take home income $7,279 per month | 18 | 8 | 5 |
The results here are no surprise, the time that it takes for a single or a couple to save for the initial upfront purchasing costs is drastically reduced in all savings rate cases. The biggest difference is seen when comparing the time required for a single person saving 30% of their take home income only taking 18 months under the first home loan deposit scheme vs 67 months when trying to save for a 20% deposit.
Minimum repayments
Table 2 shows the minimum loan repayments for the various scenarios. It’s important to note here that banks will generally demand a higher interest rate for buyers using deposit that is less than 20%. The table also shows the percentage of pre- and post-tax income required to service the principal + interest repayments in order to demonstrate the effect on a household’s cash flows. For the 5% deposit case with LMI I’ve included a $607.62 monthly LMI payment (Your mortgage, 2021).
| Single | |||
| 20% deposit, no LMI, 2.24% interest | 5% deposit with LMI, 2.44% interest | 5% deposit no LMI, 2.44% interest | |
| Minimum P+I repayments ($) | $2,443 | $3,587 | $2,979 |
| Minimum P+I repayments (% post-tax) | 32.15% | 47.20% | 39.20% |
| Minimum P+I repayments (% pre-tax) | 23.45% | 34.43% | 28.60% |
| Couple | |||
| Minimum P+I repayments ($) | $2,443 | $3,587 | $2,979 |
| Minimum P+I repayments (% post-tax) | 18.43% | 27.06% | 22.47% |
| Minimum P+I repayments (% pre-tax) | 14.66% | 21.52% | 17.87% |
What is immediately apparent is under the FHLD scheme a single person would have to devote almost 40% of their post-tax income (28.60% of their pre-tax income) towards servicing the loan. This is also under the assumption that there is not requirement for an LMI monthly fee, which may be in the order of $600 per month (Your mortgage, 2021). Couples are a little more comfortable requiring only 22.47% of post-tax income to service the loan under the FHLD scheme.
Loan pay-back periods
Table 3 shows the time taken to pay back the loans of varying sizes depending on household savings rate. It should be noted that in this table I’ve assumed that a monthly LMI payment of $607.62 is only required for the LMI case.
| Single | |||
| 20% deposit, no LMI, 2.24% interest | 5% deposit with LMI, 2.44% interest | 5% deposit no LMI, 2.44% interest | |
| 30% of take home income $2,280 per month | NA | NA | NA |
| 40% of take home income $3,040 per month | 22 years 4 months | NA | 29 years 3 months |
| 50% of take home income $3,800 per month | 17 years 0 months | 27 years 3 months | 21 years 6 months |
| 60% of take home income $4,560 per month | 13 years 8 months | 20 years 6 months | 17 years 0 months |
| 70% of take home income $5,320 per month | 11 years 5 months | 16 years 4 months | 14 years 2 months |
| Couple | |||
| 30% of take home income $3,977 per month | 16 years 0 months | 25 years 3 months | 20 years 3 months |
| 40% of take home income $5,303 per month | 11 years 5 months | 16 years 6 months | 14 years 2 months |
| 50% of take home income $6,628 per month | 8 years 11 months | 12 years 3 months | 10 years 11 months |
| 60% of take home income $7,954 per month | 7 years 4 months | 9 years 9 months | 8 years 11 months |
| 70% of take home income $9,279 per month | 6 years 3 months | 8 years 2 months | 7 years 6 months |
The results here show that in some cases, such as the single income household saving 50% of its take home income, it can take an additional 10 years to pay off the mortgage (17 years vs 27 years 3 months). In all cases having an increased savings rate reduced time difference between using a 20% deposit and the FHLD scheme. Values denoted by ‘NA’ indicate situations where the loan cannot be repaid within 30 years.
Concluding thoughts
While the FHLD scheme reduces the time required for a first home buyer to save for a deposit, it exacts a heavy toll on future household finances. This is observed through the increased payback periods and larger proportion of household income required to service the mortgage. Even if we define the total time to own a home as the sum of the time taken to save for a deposit + the time to repay the loan, using the FHLD scheme still increases the total time required own a home outright. For example, a couple saving 40% of their take home income would take 30 months (2 years and 6 months) to save for a 20% deposit and 11 years and 5 months to pay off the loan for a total of 13 years and 11 months. Under the FHLD scheme it would take 8 months to save for the deposit but 16 years and 6 months to pay off the loan for a total time of 17 years and 2 months. This represents an additional 3 years for what many would consider to a be a high savings rate. Further to this, these calculations have not taken into account stamp duty, which could represent an additional $25,000 in some cases.
Mortgage stress is often defined as requiring more than 30% of pre-tax income to service a loan. It should be noted that in the case of the single income household, taking a loan for 95% of the value of an $800,000 they would be very close to being in mortgage stress immediately.
As I have mentioned previously, leverage increases risk, and households would be wise to carefully assess their tolerance towards increases in interest rates as well as decreases in income before taking on any sort of debt. The modelling in this post highlights the effects, and risk, to a household’s finances when significant levels of debt are used to purchase a non-income producing asset. I want to finish by reiterating that these risk levels were produced by modelling income levels that are the highest allowable under the FHLD scheme and some of the lowest interest rates in history.
Engineer your freedom
References
NHFIC, 2021, First Home, National Housing Finance and Investment Corporation, available from: <https://www.nhfic.gov.au/what-we-do/support-to-buy-a-home/first-home-loan-deposit-scheme/>
NHFIC, 2022, Government announcement: Scheme places 28 March 2022, National Housing Finance and Investment Corporation, available from: <https://www.nhfic.gov.au/media-resources/media-releases/government-announcement-scheme-places-28-march-2022/>
https://www.nhfic.gov.au/media/1684/first-home-loan-deposit-scheme-fact-sheet-19-june-2021.pdf
Your Mortgage, 2021, Lenders mortgage insurance calculator, available from: <https://www.yourmortgage.com.au/calculators/mortgage-insurance>
ATO, 2022, Simple tax calculator, Australian Taxation Office, available from: <https://www.ato.gov.au/Calculators-and-tools/Host/?anchor=STC&anchor=STC#STC/questions>
ING, 2022, Savings Maximiser, ING, available from: <https://www.ing.com.au/savings/savings-maximiser.html>
ING, 2022, Home loan interest rates, ING, available from: <https://www.ing.com.au/rates-and-fees/home-loan-rates.html>
Money smart, 2022, Mortgage calculator, Moneysmart, available from: <https://moneysmart.gov.au/home-loans/mortgage-calculator>
Mortgage Choice, 2022, How long will it take me to pay off my home?, Mortgage Choice, available from: <https://www.mortgagechoice.com.au/home-loan-calculators/how-long-to-repay/>