G’day. My name’s Ben Everingham. I’m the director here at Pumped on Property and we’re a buyers’ agent with offices in New South Wales and Queensland. Today I’m going to talk about whether to use a small or a large deposit when buying property, whether that be investment or for your own home.
Hey there, my name’s Ben Everingham. I’m the director here at Pumped on Property and today we’re going to do a nice little short, sharp video on whether to use a small or a large deposit when buying a property, so I’m going to get into the positives and negatives associated with a smaller and a large deposit in a moment, but before I do that, I’m just going to share my personal story a little bit before we get started.
I’m 31 years of age at the time of recording this video and over the last seven years I’ve been able to build a multi-million dollar property portfolio and so obviously with building out a decent size portfolio, you buy a number of properties over a period of time and what I’ve been able to do over a period of time is use deposits, whether they be small or large to leverage forward and so when I first started out and I was more comfortable with risk at the time because I’d just finished university, I didn’t have a family, I didn’t have my own house, and the market place was rising extremely rapidly around Australia just after the GFC. I was comfortable putting down a 5% deposit because I knew that prices were rising by 10% per year at that time, and then I was buying well. I was buying under market value. I was buying properties that I could add some value to in the rising market, so I felt comfortable at that time in my life to use 5% deposits to move forward.
As things have changed in my personal life, I’ve got businesses which family members work in, I’ve got my own home now, obviously. I’ve got two beautiful little girls, I’ve got a wife, I’ve got a dog, I’ve got cars, so all that stuff starts creeping up and then all of the sudden, my personal tendency to take on risk for whatever reason after my first child just almost disappeared overnight and so since then I haven’t felt comfortable putting less than a 15-20% deposit down. At the end of the day deposits have everything to do with where you’re at in your stage of life and where the marketplace is at, so you’ve got to identify where you personally sit in regards to risk and you’ve also got to identify where the marketplace is at so that you can make strategic and educated decisions rather than gambling like a lot of investors, I think Australia-wide do.
It’s simple from my perspective. Every single investor in the Australian marketplace, that’s going to actually achieve a long-term result, should probably have a tendency around low-risk, which I do, and I think everybody that gets to a certain point ends up having. They really make strategic and smart decisions as opposed to leveraging extremely highly and taking on big debt, but at the end of the day that comes down to where you sit.
The second part of that is the timing side of things. There’s different times in the cycle of real estate globally and nationally and locally, and in that rising market phase, sometimes it can be good to leverage a little bit harder potentially. Again, this isn’t financial advice, this is me talking about myself personally. If I know that the market’s been subdued for a period of time, the global economy looks pretty, as far as you could call “safe,” or it looks pretty solid at that time, it looks like prices are set to rise, I might leverage a little bit harder and make the most of that rising marketplace where those good short-term gains can be made, which actually reduces your overall loan-to-value ratio at the same time, but timing is super critical. Some of the sources that I use to figure out timing are things like Residex, things like DSR, things like BIS, things like the HTW Month in Review Report, things like Residex, things like some of the quality publications in Australia. The things that guys like Phil Anderson are saying or the Daily Reckoning is saying, and just keeping a finger on the mainstream media pulse as well.
The second part of whether to use the small or a large deposit when buying a property is really around, I just wanted to talk about the power of property, and the major power of investing in property from my perspective over some other asset classes is you can leverage really hard. Let’s say that you want to buy a $500,000 property in a rising marketplace and you’re only putting in a 5% deposit, so you’re literally only having to come up with $25,000 to be able to leverage into a property worth $500K, and that $500,000 property, if it increases in value by 5% in the next 12 months, it’s just made you that $25,000 of your original seed capital back straightaway and that’s really, really, really powerful. I’m not saying go out and use 5% deposits. I personally only use 20% deposits, even more than that now, and you want a big buffer there and you want to be protected, but the power of property is in its ability to leverage, so even if you’re putting down the 20 or 30% deposit, you’re still leveraging at a decent multiplier and getting value out of that leverage, so that’s kind of exciting and that’s why I love property investing.
In regards to some of the positives and negatives associated with actually using a small deposit, we’ll start with the positives. Again, the major positive of using a small deposit is you can get into the market sooner. You can leverage forward faster, which are both massive, massive, massive benefits. Your can also keep a nice cash buffer sitting there. You don’t have to over extend yourself.
Some of the negatives associated with using a small deposit, from at least my perspective is one, risk. At the end of the day, that comes back to how you personally feel, but risk isn’t something that I like to take on. Timing’s also important and that’s a negative in some ways because if you buy at the top of the market when things begin to start sliding backwards like they do in, or like they have recently in Perth, for example, or Darwin, for example, that’s not a nice time to be over leveraged. If you’ve only put down a 5% deposit and you’ve paid $700,000 for a property in Perth and then all of the sudden that property has dropped in value and no it’s only worth $550K, at the end of the day, the bank, as long as you can continue to make your repayments isn’t going to come knocking on your door asking for that money, but if you stop making those repayments, at the end of the day you’re in a serious problem.
It’s really, really important to not overextend yourself or to over leverage yourself, and if you ever decide to do that, do it at the right time of the market. Some of the other negatives associated with using a small deposit are obvious. There’s the massive amount of lender’s mortgage insurance that you pay, which again, if the property’s going to make money because you bought really well, it’s a rising market or we can add value then sometimes that lender’s mortgage insurance can be justified, but if you’re paying above market value for a product at the wrong time, lender’s mortgage insurance is just another cost on top of that that can put you in a bad position.
The other thing with using a small deposit, which I see all the time as a negative is unfortunately when you get into financial hardship and you’ve got to sell a property, you’ve obviously got to be able to get back the cost of the property including all of the entry costs, all of the holding costs, and all of the exit costs. In an average market or a softer market or a downward marketplace, you’re not going to get your money back and you’re actually going to potentially make a loss on that property, which is never a good thing. Definitely worth thinking about those positives and negatives associated with that smaller deposit.
I suppose I’ll get back into now the positives and negatives associated with a larger deposit. The positives for me is, again, it reduces your overall risk. It gives you a buffer against tougher times personally and it also gives you a buffer against the marketplace in general if things do drop, and they have dropped in the past, like in Japan, property prices dropped overnight by 50%, like in America during the GFC. Some markets lost anywhere between 10 and 50%, so you can’t say that just because prices have risen in Australia in the past they’re going to always continue to do that in the future. Right now things in the future will definitely be challenging and things in the future will be amazing and really strong opportunities, but nobody has that crystal ball to predict exactly when that’s going to happen and so you’ve got to be a smart investor. A larger deposit can help you reduce that risk.
Some of the other positives are obviously you don’t have to pay lender’s mortgage insurance and your interest repayments on the loan are obviously lower as well, it also just puts you in a more comfortable position mentally as well, particularly if you’ve got a savings buffer sitting there as well.
Some of the negatives associated with a larger deposit is obviously, you’ve got to save the bloody thing, which can take time and can be really challenging, so it’s important to remember to weigh out if saving that extra $10,000 which might take you another four months to do is worth it or if it would be better to just jump into the marketplace and make that money from buying well and make sure you buy $30 or $50 grand below market value.
I hope you’ve enjoyed this little short video. There are positives and negatives associated with each option. At the end of the day, talk to a mortgage broker or talk to your bank manager about what’s best for you. Run some scenarios based on where your cash flow position is based on the large deposit, the small deposit. Think about how long it’s going to take in your budget to get you the small deposit or a large deposit or what equity you’ve got available, but at the end of the day make sure you think about these things before you jump in one way or the other.
Until next time, stay hungry.