Borrowing a home deposit is a high-risk venture

Sometimes innovation can genuinely save money or time but sometimes new products are not for everyone.

The latest concept of borrowing your house deposit through a specialised loan or rent-to-buy scheme is definitely one of those “not for everyone” products and should also only be used by people who thoroughly understand what they are getting into.

It is easy to see where the demand for these deposit loans have come from – in an environment in which property prices have been rising fast, being able to break into the market earlier than would otherwise be possible seems like a great idea.

Can you save as fast as prices are rising?

Then, instead of the market continually growing faster than you can save, you finally have a chance to end the property search and get on the ever more elusive property ladder.

The only problem with that sort of analysis is that market conditions can change quickly and without warning and as foreign as it might seem at the moment, property prices can fall as well as rise.

And the one thing we should all have learned from the past few years is that interest rates can fluctuate quickly as well – rising from record lows to much less comfortable levels very quickly.

It is the possibility of a crushing debt burden that is the problem with what effectively becomes a full purchase price borrowing, not to mention the potential market distortions and rising prices that could eventuate should deposit loans become more popular.

Demand is surging

One of the deposit lenders, OwnHome, claimed that it had more than $100 million of loan applications in the 24 hours after its pilot program was announced.

As OwnHome co-founder and Chief executive James Bowe put it: “We are seeing an immense demand for deposit-gap funding support in Australia.”

On the surface the people they are seeking for the product make sense, with households earning larger incomes the main target.

The deposit gap funding then aims to help them over time to reach the 20% deposit limit that many banks and other lenders set as the amount needed before mortgage insurance is not needed.

The problem is that not even a high income can guarantee that a larger loan can be serviced and even if it does, the total interest and rental repayments payable over the long term is really worth considering very closely.

Banks set serviceability requirements for a reason and that includes when times can get tough through illness, job losses or rising repayments so effectively getting around those requirements by using a deposit loan does increase risk.

Doing without the bank of mum and dad

Higher income households without the ability to use the bank of mum and dad to bridge the deposit gap could still find these sorts of rent-to-own schemes useful but they can also be expensive, depending on the specific terms of the contract, the size of the actual deposit, how fast the deposit is paid back and when the buyer actually moves from paying rent to paying a mortgage.

Typically, rent-to own schemes are front loaded so that the lending company gets around 1% to 2% of the purchase price upfront, with more of the “rent” going towards building up savings for the deposit over time, with some of the capital gain being shared between the parties.

It is possible that these sorts of schemes can work well but the big sticking point is usually the lack of a buffer to cope with unexpected extra expenses such as rising interest rates.

Caution required

As always, being educated and cautious about the specifics of any rent to own scheme or low deposit lending is essential and there really is no substitute for proper research and planning before getting star struck about the chances of getting into a property earlier than you had thought possible.

There is nothing easy about getting into the property market in Australia’s major capitals and while some of the schemes on offer might be helpful for some, there is no such thing as a magic wand.

Buying property and paying down large loans is a long and slow process and there is really no substitute for paying in extra money to reduce the impact of interest over the journey.

Higher loans or leverage always increases risk, with the caveat that in certain circumstances such as continually rising property prices and with a solid and rising income, being able to effectively buy earlier through a rent-to-buy scheme can make sense.