For young Australians, one of the biggest challenges they face is the ability to own their own home. In our practice, we are seeing more and more clients who believe that the dream of home ownership is out of their grasp.
Increasingly, we meet younger clients who believe purchasing a home and being able to enjoy a life free of money worries seems unlikely; at least that’s what they believe when they come in – affordability is a big issue.
In some cases, young people will turn to parents or even grandparents for a home deposit or to guarantee their loan. More and more adult children are moving back in with their family to boost their savings, but not everyone has this option or want to go down this path.
For young people wanting to dip their toes into the property market getting some strategies and financial discipline for saving, expenses and budgeting is essential. Sometimes instituting a savings plan for further investment, or using existing equity to create real wealth is a good place to start.
More young people are turning to investing in property first to get ahead before buying their dream home.
This means that they aren’t constrained by location and can start with a lower property deposit. Often they aren’t looking to buy in the neighbourhood they want to live in, so there is less emotion attached to the purchase. From a cash flow perspective, it is more cost effective to rent the property they want to live in than to repay a mortgage on it.
How can a young couple build a 40% deposit?
Let’s look at a young couple that is currently paying rent of $500 per week: The home they are living in is valued at $800,000 so to buy a home similar with a loan worth $720,000 (assuming a 90% loan to value ratio), weekly repayments would be $892 (assuming a five percent interest cost on Principal and Interest loan repayments over 30 years).
Let’s say for arguments sake that the couple can afford the repayment of $892 per week but continue to rent where they are. The $392 weekly surplus cash flow ($20,384 per annum) could then be used for investment and boosting their savings/equity.
Using part of their savings now for a deposit on an investment property will allow them greater financial freedom in the long run, instead of using it as a deposit on an owner occupied home.
This client’s strategy includes purchasing an investment property for $500,000 with a 10% deposit plus costs. The investment provides an after-tax cash flow of approximately $10 per week based on their circumstances (assuming a 37% marginal tax rate, combined income of $240,000 per annum, interest only repayments at five percent per annum, four percent gross yield and three percent inflation).
The couple now have $402 per week surplus cash flow ($392 from continuing to rent and $10 from the investment income) plus equity growing in the investment to build towards a 40% deposit on an owner occupied home. With an assumed property growth rate of six percent per annum the equity would be approximately $215,000 after five years and $442,000 after 10 years.
Their ideal home will cost approximately $1 million in five to six years’ time (assuming a six percent growth rate) so with careful planning and financial discipline, they’ll be able to move into their new home with the confidence that they haven’t got a massive burden in their home loan and they are improving the tax efficiency of their income.
When the time comes to buy the family home, the couple are comfortable that $750 per week is affordable for them. Assuming a $1 million purchase using a 40% deposit, principal and interest repayments are $743 per week (assuming a five percent interest rate).
There are many paths to owning a home. The traditional entry point of saving a deposit and borrowing for that first home is under threat with sky-high real estate prices. The option of building a large deposit through capital gain on well-researched property is worth considering.
Investing in property – probably outside Sydney – can provide the stepping stone to that Sydney family home.
Maria Dyson
Senior Financial Planner
Omniwealth
t: 02 9112 4305
m: 0414 285 026
maria.dyson@omniwealth.com.au
www.omniwealth.com.au