A wish everyone in the world has – if only there was a way we could buy a house with no deposit!

Well, luckily, you have inquisitive little me 😉

A few days ago, I was fortunate enough to have the opportunity to have a short Q&A with a mortgage broker from one of the largest financial institutions in Australia.

As someone closely following the Australian property market, we talked a little bit about how it was all going in Sydney (where both the mortgage broker and I are based in), especially with interest rates continuing to increase.

However, the cherry on top was when I was able to get some great tips for first home buyers; the process of buying a home in Australia, common questions, first home buyer tips, and most importantly, finding out that buying a house with no deposit is actually possible (and how to do it!).

Disclaimer: Please note that the information on this article is not meant to constitute financial advice; it does not take into account your objectives, financial situation, and needs. Consider seeking independent legal, financial, taxation or other advice to check how the information on this blog relates to your unique circumstances. Additionally, this isn’t a full transcript of what we talked about, and the Q&A had been edited for better reading.

1. So with all the talks on higher interest rates and higher mortgage repayments, what’s the mortgage lending market looking like?

We’re noticing a slowing of the lending applications, and an increase in lending applications that are declined due to a reduced borrowing power for applications as repayments go up. 

2. How much has your lending activity has slowed down? Doesn’t have to be for your entire business, but just for yourself.

Personally, I’ve received about 50% less applications compared to last year.

3. Have home prices definitely gone down, as what the media says?

Depending on the area, we have definitely seen a decline in property prices when completing valuations, as compared to earlier this year. Generally, you’ll find this in expensive areas and high density places such as in Rhodes where home prices went through the roof in 2021.

4. Have you actually received any notices of foreclosure?

Unfortunately I don’t deal with them directly – so I have no idea.

FAQ for first home buyers in Australia

5. Do you get a lot of first home buyers? What are their demographics and what kind of property do they usually aim to buy?

Yeah, I do. I’d say most of my clients are first home buyers.

Generally, they’re in their late 20s to early 30s, professional couples, most of them receive help from parents in the form of a deposit. The types of properties they’ve been looking at have been getting smaller, as their borrowing capacities have been getting impacted by the rate hikes. They mostly aim to buy PPORs (principal place of residence), usually in Western Sydney where prices are lower.

6. Has there been a slowdown in the number of first home buyers you’ve received?

Definitely, people are worried about the increasing repayments. 

7. For all our first home buyers in Australia, what is the process required to buy a home?

The first step is to get a pre-approval for your borrowing capacity with your mortgage lender (author’s note: next section). This will give you a limit of how much you can buy. The next step is to, of course, find a property – do your research, find the right one for your needs. Before offering to purchase or going to auction, make sure you get a building and pest inspection done. 

You should also request a copy of the contract of sale for the property before making an offer, and have your solicitor go through it to ensure there are no red flags. Additionally, if the sellers are unable to provide a contract, that is a definite red flag.

After all that, you can make an offer. If the offer is accepted, you sign the contract, and pay the sellers a deposit – normally 10%, but some might accept 5%, and some may accept deposit bonds. Normally, there’s a 7-day cooling off period to retract your offer; there may be some fees incurred, but you won’t lose your entire deposit. 

At this point, your bank would then conduct a valuation on the property, asking for any documents they might need from yourself such as property insurance. This is normally the most stressful time for first home buyers due to anxiety and nerves, however it’s during this time that your solicitors, the vendor’s solicitors and the bank will be doing all the work. Most of the time, you can just sit back and wait for the settlement of the property.

On the day of settlement, you will be given your mortgage, the vendor will be given their money, and they should give you the keys to your new home. Congratulations!

8. What does a pre-approval with your mortgage lender mean?

A pre-approval just means that you have your borrowing capacity evaluated to see how much your maximum mortgage can be.

Evaluating your pre-approval would require filling out an application form with the bank, for the bank to determine your assets, liabilities, and living expenses. If you’re not self-employed, you would just need to provide recent payslips and statements of liabilities (e.g. credit card statements or personal loans). Some banks are stricter and even require further documentation such as tax returns and notices of assessment from the ATO.

An important thing to note is that a pre-approval is not a commitment from the lender/bank to lend you this amount of money – it is simply an indication of what they can give you if all conditions they have are met (e.g. property value and credit checks).

9. Do you have any tips and tricks first home buyers can do to be able to own a property earlier?

Make sure you try to avoid personal debt as much as possible, such as credit cards and personal loans that massively affect your borrowing power. If you’re looking to buy an apartment, buy in a low-rise or smaller block – banks are less likely to lend you the amount you need with a big block. They usually require a higher deposit of up to 40% for those, and some might even get declined for those.

10. Why are banks less likely to lend for bigger apartment blocks?

It’s just because those properties are a higher risk to the bank, valuation-wise. Properties in bigger apartment blocks and high-rise buildings tend to not go up in value much, which could lead to a loss for the bank if you foreclose.

11. If banks are less likely to lend for bigger apartment blocks, are there also houses or types of houses that banks are hesitant to lend to?

Yes, generally this is for homes in regional areas, especially farmland. Depending on the postcode you are looking to buy in, your property might be considered “rural”. You can still buy it, banks would just require you to have a bigger deposit – about 40% or sometimes even more. 

Author’s note: Some extra information I got was that lenders have a list of postcodes that would require a higher deposit. Different banks/lenders could have a different list – so it could be good to shop around different banks.

12. Is there any way someone can buy a house with no deposit at all? 

Actually, yes. But you will require the bank of mum and dad to be on board. 👪

A big one is that if you don’t have enough for a home deposit, but someone in your family is willing to help, they can offer a portion of their property as security for your deposit (more info in the next section).

This way, you don’t actually need cash upfront, and can borrow 100% of the value of your property, plus stamp duty – provided that your income can service the total loan you need and there’s enough equity in your family’s property. This is called cross-collateralizing using a family guarantor. 

As previously mentioned, sellers of a property also usually require a 5-10% deposit once they accept your offer to buy their house.

If you don’t have the cash for a deposit, you can opt to take out a deposit bond, which is used as evidence that the entire property purchase price will be given to them on settlement date. If the seller accepts the deposit bond, you won’t to pay the usual cash deposit.

Using a family guarantee and a deposit bond, you can buy a house with no deposit.

13. How does a family guarantee mortgage work?

Normally, a bank would require a minimum of 5-10% deposit. Anything below a 20% deposit would also mean you have to pay lender’s mortgage insurance (LMI), which can be tens of thousands of dollars.

This is where your family comes in. If they have enough equity in their property (which is calculated as 80% of their current property’s value minus existing mortgage amount), they can offer this equity as security/collateral to the lender for the property you want to purchase. This way, you can avoid LMI.

14. Can you give an example of a family guarantee?

Yes of course.

Let’s say Ben wants to buy a property worth $1,000,000. He has no savings, since he just started his career. However, Ben earns a large income, enough to service a loan that would cover $1M + stamp duty – he just does not want to have to wait till he has enough deposit for a house.

Fortunately for Ben, mum and dad are willing to help out. While they are unable to give him cash for a deposit, they own a beautiful home with a good amount of equity (again, calculated as 80% of their current property’s value minus existing mortgage amount).

Ben’s desired property: $1,000,000

Stamp duty on $1,000,000: $40,090

Required deposit to avoid LMI: 20% or $208,018, which means Ben’s loan-to-value ratio (LVR for short) must be 80%.

Mum and Dad’s property value: $1,200,000

Mum and Dad’s mortgage: $500,000

Available equity in their property calculated as: ($1,200,000 x 80%) – $500,000 = $460,000

Mum and Dad tell the bank that since Ben is borrowing 100% of his property’s value (i.e. $1M), in order for Ben to be able to purchase his home and skip on paying LMI, they can offer Ben’s 20% deposit to be secured/guaranteed by their home. Additionally, they can also secure a bit more for Ben to include the cost of stamp duty in his mortgage.

With stamp duty, Ben’s total loan amount will be roughly $1,040,090. Since Mum and Dad’s equity is $460,000, they are able to be guarantors for 20% of the loan value ($208,018).

Voila! Ben is buying a house with no deposit whatsoever – he only has to make sure he can afford the repayments on his $1,045,000 loan.

15. What are some common mistakes that first home buyers make?

If you are looking to buy a property, make sure you get a pre-approval beforehand, to ensure you can actually complete the purchase. Pre-approvals generally last 90 days, you can use this time to find your perfect property. I’ve seen many home buyers place a deposit on a property and seek pre-approval after. Turns out they couldn’t borrow enough to complete the purchase, and ended up losing their cash deposit.

And that concludes our interview with our wonderful mortgage broker!

Hope you were take away some important lessons. I’m personally looking to purchase my own PPOR next year as well, and will mostly use what I learned in this Q&A in order to buy my house with no deposit.

Please do share your story if you used any of the tips here!

If you read the news regularly, you wouldn’t be a stranger to the plethora of articles stating that the Australian Real Estate market is due for a massive crash (20-30%) in 2023. Much of the pessimistic analyses comes as a result of the rising interest rates happening globally, in the world’s bid to tame decade-high inflation rates.

As an analyst planning to finally dip my toes into the highly-revered housing market next year, I thought it prudent to actually look at the correlation (though we are definitely not going into deep statistical analysis here) between Australian Real Estate prices and interest rate increases. Additionally, I wanted to see whether house prices really did fall in the past when interest rates increased. Please note this was all written in the span of a six hours, so please spare any typos. (Did it as a challenge to myself 😂)

Introduction to Interest Rates and their effect on the Australian Real Estate Market

What are interest rates and how do they work?

Before we dive in, don’t forget that this website is Finance for Noobs, and that the goal of my writing is to explain these complex financial questions to our wonderful newbie investors! As such, let us start with explaining what exactly the relationship between interest rates and real estate have.

Australian households (unsurprisingly) have the fifth highest household debt in the world at approximately $86,000 worth of debt compared to their $42,000 of household disposable income. Additionally, the percentage of households’ total credit to the entire country’s GDP is at a staggering 120% – which effectively means that Australians have more debt in total than Australia’s annual economic output (a very rough explanation, but this is what it means in short)! Australians are in a crazy amount of debt – much thanks to our equally crazy real estate market!

Now, if you have any taken any line of credit/debt (e.g. credit cards, personal loans, mortgage loans, car loans), you would know that all of them come with interest payments. Interest exists because of inflation –  your money losing value over time (e.g. that $1 meal you used to have 20 years ago is now worth $10) – banks wouldn’t lend you money for free if their money is going to be worth less when you pay it back!

Interest payments are then based on a set interest rate – this rate is generally based on the Reserve Bank’s (RBA) cash rate. At an annual interest rate of 3% for example, you would be paying $30,000 in interest payments a year for a $1M loan.

What is the effect of an interest rate increase on a mortgage?

As such, when the Reserve Bank hikes interest rates, banks and mortgage lenders also subsequently increase their rates. For those with mortgages, this means that your repayments will be higher (e.g. your rate going from 3% to 4% on a $1M loan would mean you are paying $40,000 a year now on interest payments).

And for those without a mortgage YET (who pays for Australian real estate in cash? 😭), you will find that you can borrow less due to the higher rate. This is because the bank calculates your borrowing capacity based on how much you can repay.

To provide a very rough illustration, if you can only afford interest payments of $30,000 a year (e.g. 3% of a $1M loan), if the interest rate is increases to 4%, you can now only borrow $750,000 – 4% of $750,000 is $30,000; with your repayment capacity still at $30,000, a higher interest rate will mean you can no longer borrow that $1M.

Note: While the calculations of your borrowing capacity is more complex in real life, hopefully these examples help you get the gist of how an interest rate increase affects your mortgage. If you would like to play around with calculations, I would recommend the government’s very own mortgage and repayments calculator. Example below.

With Australians being one of the most indebted people in the world, how many people do you think would struggle with higher interest payments? 😨

What is the effect of interest rate increases on the Australian Real Estate market?

Now that you know how interest rates work and how they affect people’s mortgages and borrowing capacities, do you have any guesses as to how this actually affects the housing market as a whole? 🤔 You probably do (because I believe in you!), but I shall still explain a little bit just to ease any doubts.

Firstly, remember that an interest rate hike affects not just mortgage interest rates, but all the lines of credit that a lender has. Higher debt repayments would mean that people who have any form of debt will be seeing less money in their savings accounts after their periodical repayments. People who are very highly leveraged (fancy way of saying that they are very much in debt 😶‍🌫️) are especially prone to this.

If interest rates increase a lot – in Australia, the rate has already increased by a staggering 2.5% from the start of 2022 – people will soon start to become unable to pay off all their loans. In effect, some people may be forced to sell their properties. So far, we have already started seeing this phenomenon in the capital cities where house prices are insanely high.

Additionally, people who haven’t gotten mortgages yet will see their borrowing capacity drop by a fair bit. This means that real estate, particularly pricier ones, will see less potential buyers.

With people selling more properties due to higher interest payments, and less buyers in the market, do you see what’s going to happen? Yes, most likely dropping real estate prices, as housing supply outstrips demand.

A look into the past: Historical relationship between the RBA’s interest rate and the Australia’s Real Estate market 👀

SO, now that we’ve finally gone through that lengthy intro-to-interest-rates-for-noobs, let us finally move on to the main point of this article. Do note that this part will have a few graphs, and might be a bit confusing as it’s more a more advanced topic.

The question we are trying to answer: Will house prices really fall next year?

To start with, analysts and economists from Australia’s major financial institutions predict real estate prices to fall between 10% (RBA forecast) to 20% (ANZ) in the next few quarters due to the rising interest rates. Some retail investors even believe a 30% crash in the following year.

Slowing growth in Australian real estate prices

Now, according to Proptrack, a subsidiary of the REA group (who owns realestate.com.au), the growth in house prices has already begun slowing down this year:

Before anything, do note that this is a graph in the annual change in house prices (i.e. year-on-year house prices) and not the actual change in median house value – as such, as long as the lines below remain above 0, house prices are still higher than the year before.

At first glance, home price growth for Sydney and Melbourne began dropping as early as late-2021 – well before the first RBA rate hike in May of 2022. Mid-2022 finally saw growth rates go into negative territory; which means that compared to the year before, house prices have gone down. This is also the latest data from Proptrack taken from its October 2022 report. With the forecasts for 2023 being a drop of 10-20%, Sydney and Melbourne’s 4% and 2% YoY drop seems to still be a far cry.

Similarly, other capital cities experienced their growth rate peaks between 2021-2022. The growth in house prices have slowed down, however, none of the other capital cities have yet to actually experience declining house prices. Similar to Sydney and Melbourne however, growth in the house prices had slowed down prior to the first rate hike.

Changes in the RBA cash rate vs. Real residential property prices

Now, recall that the big banks and the RBA both think that house prices will fall 10-20% next year due to interest rate increases.

Let us examine this.

In order to see the effect that interest rates have on house prices, look at the nifty little graph I made that combines the first two on inflation-adjusted house prices and the RBA’s cash rate:

Before:

This is the graph for the Real Residential Property Prices. Real means the property prices are adjusted for inflation. An index aggregates the data of the property prices and makes it easy for us to see the movement in prices. Think S&P 500 index.

With my magic:

Unfortunately I couldn’t change the colour of the lines, so just take note that the thicker line is the RBA’s interest rate graph.

Now, let’s add some arrows:

I have masterfully combined the two graphs (you are welcome heh), and also added arrows for you to see the movements of the graph. The red arrows refer to the movement of the RBA’s interest rate, while the black arrows refer to the movement in inflation-adjusted house prices.

Now that I’ve made this all easy on the eyes, let’s take a closer look. We are trying to see whether interest rate increases/decreases actually lead to decreases/increases in house prices. The argument is that they are inversely-related.

Back between 1990 to 1994, the RBA’s interest rate took a steep decline – going from about 18% to just 5%. During this time, contrary to our expectations, inflation-adjusted house prices BARELY moved, if any. Given the much lower interest rates, you would’ve thought that the demand for houses would have gone up as more people could afford mortgages and had higher borrowing capacity.

Additionally, the period between 2002 to 2008 saw interest rates increasing – but real estate prices ALSO INCREASED. In fact, at the beginning of the interest rate decrease in 2008, house prices ALSO decreased; however, this could arguably be because of people experiencing fear from the global financial crisis.

So far, it seems like interest rate changes haven’t actually inversely affected house prices.

As we continue along the graph, interest rates have steadily gone down as the country goes into expansionary mode (or cheaper credit) in order to grow the economy after the wake of the GFC. Rates were increased a teeny bit in 2010 (about 1.5%), and you can see house prices fall slightly in the next few years (2011-2012). We can finally see an inverse relationship between the interest rate and property prices here – and it continues on for a few more years as the RBA rate continues to fall. However, upon reaching 2017, house prices fell quite a bit when the RBA’s cash rate remained stagnant.

Will house prices go down in 2023? The verdict.

I can definitely see some semblance of an inverse relationship between the interest rate and house prices – however, I don’t think interest rates have as much effect on house prices as all the recent news make it out to be.

Sure, in the span of 30+ years (1990-2022) the interest rate had gone from about 18% to 2.35%, and long-term house prices over those 30 years had also tripled. However, if we are looking at house prices falling 20-30% by 2023, as some estimates have it, I would say that based on history, this is unlikely to happen. 10% may be probable though.

Additionally, this would most likely only be a short-term drop in real estate prices (few months to 2 years). The interest rate as it is now (2-3%), is a far cry from the previously double digit interest rates our parents had to endure. Not only that, Australia’s government looovvveeesss real estate! Look at the number of subsidies and first home buyer grants available – too many to prevent a massive plunge in house prices! Banks will also do all they can to prevent a foreclosure; we have interest-only repayments, refinancing, their ability to offer you a lower interest rate if you ask, and so on.

Hope this article was insightful! This is my first analysis into the property market, so please do let me know what you think. Also, please do have a read of my other articles. My story on Qantas Points seems to be the most popular!