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I've been asked to give some advice to would be homeowners about making the deposit for a mortgage. More specifically, methods and resources to help stump up the up to 30 per cent down payment required to buy your first home.
Initially, it struck me that this would have to be a very short article. There's only one way to make a down payment: Save. Pay your deposit.
As dismissive as this sounds, you really don't have an option. Some people might consider taking a personal loan from a bank or lender in order to finance the initial payment for a mortgage. In most cases, this is illegal. In all cases, it is ridiculously unwise.
The reason that mortgage lenders insist on part of the price of the house being paid by the buyer is to prevent negative equity (where a property value falls and the owner finds they owe the bank more than their home is worth) and to ensure affordability and, therefore, reduce defaults. In fact, since the global financial crisis and credit crunch, financial authorities around the world and particularly in high-risk areas for real estate speculation have been pushing through regulations to fix the maximum loan-to-value percentage for mortgages.
Even if you can afford the payments on a loan and a mortgage and you are legally allowed to use the former to apply for the latter, you will find that the much higher interest rates applicable to a personal loan will vastly increase the cost of your borrowing. A 30-year repayment mortgage in mid to late 2016 can easily be found for around 3.5 per cent when you are borrowing dollars or dirhams. A personal loan or credit can be double that or even higher and might need to be paid off in five years.
This means that anyone who decides to take out a loan in order to obtain a mortgage will have to deal with a monthly repayment over the first five years three times higher than the mortgage alone. Suddenly renting seems cheaper and safer.
Some people might be fortunate enough that they have parents, friends or other family members willing and able to help them with the deposit for a home. This can be a much safer option but always beware. Few issues can ruin a relationship as quickly and irreversibly as a major financial dispute.
The only way to make your deposit is if you have saved the money. This presents a further question about the best method for saving up that lump of cash in the first place. This is more in the remit of a financial adviser and surprisingly easy to answer in three steps:
First, decide how much you'll need. Don't be vague about this, put a figure on it. You will know the approximate property prices in your area and the percentage needed as a down payment for a mortgage. If you don't know, it's not hard to find out. Once you have decided on your cash lump sum target, write it down and decide how flexible you can be if you don't quite reach that number.
Second, set yourself a timescale. Again, don't be vague. You need a limit to work within. Aiming to buy in the next five to 10 years won't cut it. Decide when you will start looking for suitable properties and when you will sign the title deeds.
Finally, now that you have a target amount and a deadline by which you must reach that target, you are ready to formulate your method. If you meet your financial advisor with your decisions from steps one and two written down and tell them you want help with step three, they will be your best friend.
A delicate word of advice here. If at any point in this three-step process you find that you are unable or can't be bothered to be precise, to make definite decisions or ask for help, you are just trying to convince yourself that you want to buy a house. You are not really serious about it. In this situation, pick up the phone, call your friends, go to spend some time with them and tell them how you once considered investing in property. You will save an awful lot of money.
Assuming that you have managed to complete steps one and two then for step three, your financial advisor will tell you that there are only two real ways to generate your target pot of cash by the target date.
Number one: Put a smaller lump of cash into an investment that will grow into the bigger pot of cash.
Number two: Put much smaller lumps of cash into the pot on a regular basis until the target pot is full.
The first option is great if you have existing savings, but always be aware that investments are never guaranteed to go up and not down. If disaster strikes, you may find yourself with less money than when you started out. For a stable investment with very low risk, it should be fairly easy to achieve an annual return of 4 per cent. However, with compounding over five years this will only generate 22.1 per cent more than you had in the first place. Higher returns are possible, but they come with a greater chance of losses. If you want a fixed sum with minimal risk, you need to have a fairly significant sum to invest on day one.
The regular savings option is more approachable for most investors. The reality of putting away a small amount each month is easier than locking up a big lump of cash. On top of that, if you invest that money then making regular deposits can average out the impact of a bad period in the markets. Furthermore, seeing your regular investment amount as a normal monthly expense is the best preparation for the monthly cost of paying your mortgage in the future.
Ultimately, the fastest, safest way to reach your target is a combination of both methods. Invest existing savings wisely with a fixed target in mind and then supplement that amount with a monthly deposit into a fixed-term account. If you plan your strategy well and stick to your own plans, you'll be crossing the threshold of your dream home, right on schedule.
Find out the reason why buyers have to invest in property for the long term to maximise gains
Source: Edward Mainwaring-Burton, Special to Property Weekly
The author is Senior Financial Planner at DeVere Acuma