Purchasing a principal residence is a huge financial commitment. It can be a fantastic strategy to help secure and grow your financial position, but care needs to be taken to ensure you buy the right property and don’t over commit yourself to something you can’t afford.
In this article we consider the key elements when buying a principal residence, the pros and cons of owning your own home, and of course, the Guided Investor approach to home ownership.
Location, location, location.
When buying a property, one of the most important elements to consider is the location. This is particularly important for a principal residence as the location should be the perfect compromise between where you want to live from a lifestyle perspective, and what is a smart buy from an investment perspective.
The lifestyle element is very personal. When determining where you want to live, you need to factor in elements such as proximity to work, proximity to family & friends, school district, amenities, access to key infrastructure, and of course, the general vibe of area – would you be comfortable living there?
From an investment perspective, we turn to a concept called ‘rare earth’. This takes into consideration scarcity – a key concept of any good investment decision.
There is only so much land in this world and, more importantly, some of that land is more desirable because of it’s location. For instance, land close to the beach demands a higher price than than land in the middle of a desert. If that beach is also close to a city centre and great amenities , that again increases its desirability and therefore value.
Scarcity of the location of your property will likely be the key driver of the property’s value over time. The key drivers of scarcity that we look for in property, include the following:
- Distant to the central business district (CBD);
- Distance to natural resources such as the ocean or river;
- Distance to infrastructures such as schools, parks, highways, etc.
All of these areas are highly sought after and have limited space available. If you can find a property that ticks multiple boxes, you are onto a real winner!
Financing your home purchase
Location is one thing, but affordability is another. It’s all good and well to want a property in the perfect suburb, but you also need to be able to afford it. The affordability aspect is where compromise between your dream home and practicality meet.
When considering affordability, there are two key aspects; deposit and serviceability.
The deposit is how much you have saved to put towards the purchase. Typically, it is suggested to have a 20% deposit plus costs, as this will give you the best loan terms and no lender’s mortgage insurance (LMI). However, that can be a significant amount to save and there are other ways into home ownership with a much smaller deposit.
The second factor is serviceability. Serviceability is your ability to pay for (or service) the loan. It considers how much you can borrow based on your income and expenses. The higher your income, the more you can borrow. The higher your expenses, the less you can borrow. Some of the key items that can impact your serviceability are number of dependents, existing loans, age and living expenses.
There are a huge number of factors that need to be considered when assessing both deposit and serviceability. To assist with this, we recommend you speak with a Mortgage Broker. They will walk you through the intricate details and help establish a budget for your property purchase based on your deposit and serviceability.
Always remember, just because you have a maximum borrowing capacity, doesn’t mean you should be borrowing the full amount. The amount you borrow needs to tie in with your financial plan. If you want our help establishing an appropriate financial plan, see Tailored Advice.
Benefits of home ownership
There are many potential benefits to home ownership. This can include the following:
- Financial security. Owning the roof over your head can give you significant financial security as no one can kick you out, you can do what you like with the property (subject to council restrictions of course!) and your not subject to rent increases. When the mortgage has been paid out in full, a massive item in your budget (housing costs) is significantly reduced.
- Ability to borrow against equity. Equity is the difference between the value of the house and the amount you owe. In Phase 2 of Wealth Creation, there are many wealth creation strategies you may choose to deploy by leveraging off this equity.
- No capital gains tax. There is a main residence exemption which excludes your primary residence from capital gains tax upon sale.
- Discipline. By taking on a mortgage you take on a BIG financial obligation. You will have regular loan repayments that you need to meet – rain, hail or shine – otherwise serious consequences will apply. This brings forced discipline to your cash flow.
- Diversification. Physical, tangible property is a great asset class to hold as part of your overall portfolio alongside other asset classes such as cash, shares and bonds.
Risks of home ownership
Despite the many benefits of home ownership, there are also a number of risks that need to be taken into consideration. Let’s consider some of those risks now:
- Interest rate risks. If you borrow to purchase your home, you will be subject to interest rate risks. This is the risk that interest rates will rise, causing the cost of borrowing to increase which, in turn, increases your minimum repayment. This risk can be reduced by using fixed rate loans, but typically the fixed rate will only last for 5-years.
- Transaction costs. Properties are expensive to buy and sell thanks to the high transaction costs such as stamp duty (try our Stamp Duty Calculator). You should typically purchase a property with the intention to hold it for the long term.
- Maintenance costs. There are many costs to maintain a property such as rates, maintenance, insurance and utilities (just to name a few). As the owner, it is incumbent upon you to cover these costs.
- Falling house prices. The price of your house will be driven by market forces which are out of your control. It is not guaranteed that the value of your property will increase over time.
- Failing to meet loan obligations. Generally speaking, the debt used to purchase your home will be secured against the property itself. Failing to meet the mandatory loan obligations could result in the asset being seized and sold to pay out the debt. One way to help reduce this risk is to ensure you have the appropriate personal insurances in the event you were unable to work.
The Guided Investor approach
Here at Guided Investor, we believe that property is a great asset class to hold as part of your diversified portfolio, offering characteristics unique from other asset classes like shares, cash and bonds. By owning the roof over your head, you get a sense of financial security, peace of mind and even pride.
While property isn’t suitable for everyone, it can be appropriate for many. As part of Phase 1 of Wealth Creation, we often suggest property as part of establishing your financial foundation. By buying a property and building equity in that property, you will not only help secure your financial independence, but you also open yourself up to a whole new world of wealth creation strategies in Phase 2.
