How to Buy a Property
*article by Financial Coach Garry Millburn
When it comes to buying a property, it can often be a case of you don’t know, what you don’t know.
Whether you are about to buy your first home, your first investment property or perhaps you have a few properties but know it’s time to up your game and maximise your strategy. This is a millennials go-to guide for what you should keep top of mind when buying property.
It can be broken down into four main sectors. These highlight the things you will want to take into consideration and what the implications could be for you.
Spending big amounts of cash and getting yourself into big debt, it’s a daunting prospect for most people. So it’s common to see people become as emotionally invested as they are financially invested. Emotions are natural, it’s exciting and scary all at the same time.
However, you are making a financial decision, so you need to check your emotions at the door* and bring your level-headed self to every decision.
Most likely this property is going to be a stepping stone to your dream home or financial freedom. So make sure it’s ticking the boxes of your long term goals and is a sound investment choice.
Get unemotional about it, know your criteria, know the numbers you need – the spend, the returns and make sure they are adding up. The criteria and the numbers do not lie, so if it’s not hitting them and you are unemotional about it, then it’s easy to walk away to find something that does tick all those boxes.
*There is one emotion you can take with you, gut feel. If it doesn’t feel right there is no harm in walking away.
Cash Money or Not
Banks are tightening up their lending criteria, with good reason. It is becoming harder to secure a loan with less than a 10% deposit. And don’t think you can simply be gifted your deposit by family because banks often want proof that you can save.
There is an alternative if you are between a rock and a hard place with saving money and paying rent. It is called having a loan guarantor. The most common scenario is your parents using part of the equity in their home to guarantee a portion of your loan. This will not only allow you access to a loan but in most circumstances will avoid LMI (Lenders Mortgage Insurance).
LMI will usually apply if you are borrowing more than 80% of the property value. In some cases, if you are self-employed or have what’s considered a low document loan, it will apply when you are borrowing 60% or more of the property value. It can be added to the value of the loan and paid off with your regular repayments.
Is this a bad thing? Not necessarily, for millennials in today’s market, it could be more cost-effective. Instead of waiting the additional time to save additional deposit, and running the risk of the property marketing dramatically increasing, you access a loan with LMI.
LMI is calculated on a variety of factors, your lender, the insurer, loan to value ratio, employment status, term of your mortgage and more. To give you an indication, with a $500,000 property value, a 10% deposit ($50,000), loan value $450,000 it would be around the $9,000 mark.
Strategy + Structure
Most millennials don’t even know there are options because they are doing what their parents did and what they know. Buy a property and pay it off.
But, there are options on how to structure your loan and, depending on your circumstances, different strategies to use.
A loan can be structured in two ways:
- P+I (Principle + Interest) – where you are paying of the principle of the loan (the amount you borrowed) along with the interest component.
- IO (Interest Only) – where you only pay the interest component and the loan value stays the same.
P+I and IO loans will in most cases have different interest rate offerings. You need to consider whether the value is worth it for your circumstances.
Let’s run through some of the reasons you would choose an IO loan.
- Lower repayments with the ability to switch to P+I as your income increases.
- If the property is for investment purposes the interest component is taxable and depending on your circumstances this could be tax effective (negative gearing).
- You may want to put the principle component into other investments.
One way to mitigate some of the interest costs, but have flexibility and control over your money is to have an offset account against your loan. Most banks allow this, in some cases there may be a very small monthly fee.
An offset account does exactly what it sounds like, it offsets your loan. The money you put in this account offsets the amount you owe on the loan and you are only charged interest for the difference. For example, if you have a $400,000 loan and you place $20,000 in your offset account the interest you are charged is based on the difference of $380,000.
This allows your IO loan to act like a P+I loan, however now you have the ability to access the money sitting in the offset account for emergencies or other opportunities. It’s a lot easier to set up an offset account than to ask your bank for more money!
Don’t forget when buying a property there are other costs involved apart from the deposit and loan. These can really add up to some big numbers and it’s worth taking a look into these costs prior so you aren’t left in a squeeze.
Stamp duty will most likely be your second biggest cost after the deposit. Depending on your location the government or developers often have different schemes to help first home buyers. So look at what is available and what suits your circumstance.
Other costs include conveyancing fees, building inspections and strata reports. These can add thousands of dollars to the overall costs and prices can vary significantly. Do your research and shop around for a competitive price from a reputable provider.
This should help you get well and truly underway with buying your property. And give you some food for thought on alternate way for you to make your property purchase work for you!