Low Deposit Home Buyers Beware of the Low Equity Premium

Another day, another new low mortgage rate! A race to the bottom isn’t usually regarded as a good thing. But for those seeking a cheap mortgage, the regular lowering of bank interest rates can only be a good thing.

But while there are some very, very good deals out there if you’ve got at least a 20% deposit. If you’ve got a smaller deposit … not so much!

Check the small print

If you take a quick glance at a bank’s new low interest rate figure, it’ll look great, until you check the small print.

Look a little closer and you’ll see that a bunch of conditions apply, the most important usually being that the rate only applies to those people with a 20% deposit or greater.

If you’ve a smaller deposit, you can expect to pay more, in the form of a higher rate and/or a low equity premium (LEP).

What is a low equity premium?

An LEP represents extra interest, or an additional one-off charge, on top of your mortgage. Depending on the size of your deposit and your lender, it can range from an extra 0.25% to 1.5% per annum, or a 2% premium on the amount of your loan.

LEPs were initially put in place by the banks to cover the extra costs associated with the introduction of the loan-to-value ratio restrictions, in 2013. But even though the LVRs have been scrapped, LEPs remain. And for those with low deposits, the result can add up to a sizeable difference from the ultra-low special rates that are advertised.

For those with less than a 20% deposit, three of the four major banks charge LEPs as annual extra interest charges (figures correct as of 08/12/2020):

Fixed 1-year rate: 2.49% p.a. (Minimum 20% equity)

Standard fixed 1-year rate: 2.49% p.a.

Low Equity Premium:

• 80.01% – 85% LVR: 0.35% of loan amount p.a.
• 85.01% – 90% LVR: 0.75% p.a.
• 90.01% – 95% LVR: 1% p.a.
• Over 95.01% LVR: 1.15% p.a.

Fixed 1-year rate: 2.49% p.a. (Minimum 20% equity)

Low Equity Premium:

• 80.01% – 85% LVR: 0.3% of loan amount p.a.
• 85.01% – 90% LVR: 0.75% p.a.
• 90.01% – 95% LVR: 1.3% p.a.
• Over 95.01% LVR: 1.5% p.a.

Special fixed 1-year rate: 2.49% p.a. (Minimum 20% equity)

Standard fixed 1-year rate: 3.09% p.a.

Low Equity Premium: 0.25% – 1.5% p.a. depending on size of deposit

As you can see from the above figures, if you’ve less than a 10% deposit, you could end up paying a lot more than a bank’s special rate. For example, at Westpac, your interest rate could be as high as 4.59% – 2.1 percentage points higher than their attention-grabbing special fixed 1-year rate of 2.49%

Over at the ANZ and Kiwibank, the low equity premium is charged as a one-off fee, which can be added onto your loan. As you can see below, those with less than a 20% deposit have to pay substantially more for their mortgage.

Special fixed 1-year rate: 2.49% p.a. (Minimum 20% equity)

Standard fixed 1-year rate: 3.09% p.a.

Low Equity Premium:

• 80.01% – 85% LVR: 0.25% of loan amount
• 85.01% – 90% LVR: 0.75%
• Over 90.01% LVR: 2%

Special fixed 1-year rate: 2.55% p.a. (More than 20% equity)

Standard fixed 1-year rate: 3.3% p.a. (Less than 20% equity)

Low Equity Premium:

• 90.01% – 95% LVR: 0.25%

Not all bad news

Yes, if you’ve less than a 20% deposit, it’s likely you’ll have to pay more for your mortgage, but it isn’t all bad news. Due to the way that ongoing LEPs are calculated, as you pay off your loan and, hopefully your property rises in value, your LEP should diminish as your equity in your home rises. For a more detailed case study, check out our story: Low Deposit Home Loans Come With A Costly Catch.

To ensure that you’re not out of pocket, you’ll need to keep a close eye on house prices in your area and the size of your debt. Banks won’t actively revise the LEP that you’re paying, unless you contact them and ask for a re-evaluation of the price of your home and your equity in it.

Ultimately, it pays to shop around. If you’ve a stable income and a good savings history, you could be able to negotiate a great deal even without a 20% deposit.

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