12 Jul 2018
Wealth Potential
First Home Buyers – What You Need to Know.
By Emily Matthews

Property. The Australian Dream. We all want to be a part of it, but what’s the best way to get involved?

The median house price in Australia is approximately $820,000. Most banks expect a 20% deposit before they will even consider approving a home loan. That equates to $164,000! Fortunately for those of us that live in Brisbane, median house prices here are approximately $552,000. Which means your 20% deposit is only $110,400…

No wonder the average age of first home buyers is 32! Saving that kind of cash in your twenties is seemingly impossible. Especially with the cost of tertiary education forcing most of us into student debt early on.

But, let me assure you: getting into the housing market in your 20’s is indeed possible. Even if you eat avocados!

First, it’s important to understand what impacts your borrowing power.

While saving towards your deposit is essential for banks to seriously consider your eligibility for a home loan, other factors may impact your borrowing power. Generally, all banks require a credit history check. Although credit history is fundamentally important for the approval process, credit card debt or a personal loan or car loan, may heavily impact how much the bank will lend you.

If you have an existing credit card, it might be ideal to reduce your credit card limit as banks consider the limit amount as the amount owed. If your credit card limit is $10,000 but you repay your credit card monthly and apply with a $0 owing balance, the banks will still consider this as a $10,000 debt. This could significantly impact your borrowing power by tens of thousands of dollars. By simply reducing your credit card limit, you could increase your borrowing power substantially.

Reducing or, even better, eliminating your current debt now will better prepare you for your home loan application. Strategizing how best to make your repayments plus increasing your savings can be a daunting task. But with a plan in place and strict discipline, it’s not impossible.

How to save for a deposit and alternative options available to consider.

As mentioned above, the deposit amount required by most banks is usually 20% of the purchasing property value. This can be a cash deposit upwards of $100,000.

Lenders Mortgage Insurance

The banks do offer Lenders Mortgage Insurance (LMI) if you are unable to produce the full 20% deposit. However, this is not to be mistaken as insurance for you. LMI is security for the lender to ensure that they will not incur a loss should you default on your home loan. This is why banks request a 20% deposit prior to considering your loan.

However, most banks still expect a deposit of at least 5% and the ability to view consistent savings through your transaction history, prior to approving you for LMI eligibility.

The cost for LMI is most commonly added to your home loan. It is important to understand that once LMI is added to your home loan principal, you will be paying interest on top of the LMI amount and your minimum regular repayments will increase accordingly.

Guarantor

Alternatively, if you are fortunate enough to have parents (or a close relative) with equity in their own home, they may be eligible to become a guarantor for you. Becoming a guarantor on a loan essentially means becoming the security on the home owner’s loan. This is a strategy to avoid the cost of LMI if you have not saved the 20% required for a deposit. However, if you default on your home loan, your guarantor will be liable to repay the portion of the home loan they have become guarantor on. Most banks request the guarantor to seek financial advice before committing to this strategy.

Government Initiative

To assist and encourage Australians to save towards their first home, the government previously offered first home owners saving accounts. These had great incentives including an additional contribution of 17% for the first $6,000 deposited each financial year. Unfortunately, the government abolished these accounts as of 1 July 2015 and introduced a more complicated first home owner saving scheme as of 1 July 2017.

The First Home Super Saver Scheme (FHSSS) allows for up to $15,000 of voluntary contributions to be made into your superannuation each financial year. Voluntary contributions categories include;

  • Non-concessional contributions (after-tax has been paid at your marginal tax rate), capped at $100,000 per annum
  • Concessional Contributions (pre-tax), capped at $25,000 per annum.

There is no tax benefit associated with making a non-concessional contribution. And appears pointless to make this type of contribution for this reason.

Concessional contributions however, carry a discounted tax rate at 15%. Concessional contributions can be made via salary sacrifice. Superannuation Guarantee Contributions (SGC) are typically 9.5% of your salary. However, if you work for the government, your SGC could be anywhere up to 18% of your salary.

Let’s assume your annual salary is $60,000 per annum plus super of 9.5%. Your marginal tax rate is therefore 32.5% and your annual superannuation guarantee contribution (SGC), paid by your employer is $5,700. Annually you can expect to pay $11,047 in tax on your income and your superfund is liable to pay $855 in tax. Totalling $11,902 tax paid per annum.

However, if you’ve decide to implement a salary sacrifice arrangement with your employer (assuming your employer is happy to make said arrangement) and you opt to salary sacrifice $15,000 over the financial year, you, or more specifically, your superfund is liable to pay $2,250 in tax on this contribution. Your annual income has now reduced to $45,000 per annum (before tax). Your tax on income has reduced to $6,172 per annum. In total, including your SGC, your super has paid $3,105 in tax over this financial year. Total tax paid equals $9,277.

Saving $2,625 per annum in tax.

However, the maximum that can* be released from your superannuation account to use as your deposit is $30,000 of personal contributions plus associated earnings. The total amount then withdrawn will be taxed at your marginal tax rate minus a 30% tax offset. As per the example above, the marginal tax rate is 32.5%. Therefore 2.5% or $750 will be payable in tax on the $30,000 withdrawal (not including earnings).

Also, important to note, when you do withdraw these funds, they MUST be used in conjunction with purchasing your first home. If you do not end up buying your first home, these funds are locked away until you have met your preservation age.

Complicated. I told you so. Is the complication worth the overall benefit? You’re still almost $80,000 short on the 20% deposit required for purchasing the average valued house in Brisbane… Not to mention, the process to make this withdrawal is bound to incorporate another level of complexity and time. People who have made this type of contribution into their superannuation are eligible to withdraw from 1 July 2018.

Remembering, there’s the underlining risk if you can’t purchase a house for any reason, you won’t be able to access these funds until your preservation age has been met.

In addition, if you haven’t adjusted your investment options upon making these short-term contributions, you could be affected by timing risk. That’s a whole new kettle of fish.

In light of my comment above regarding being short $80,000 for the deposit, from 1 July 2018 the government is offering a first home owner’s grant of $15,000. Terms and conditions apply.

*Note: The release of superannuation funds is still subject to the superfund. For example, funds from a defined benefit or constitutionally protect superfund may not release the money.

Strategies to Save for a deposit.

The above support by banks and family is great. But you still need to save an initial deposit or have proof of decent savings at minimum. Below are a couple of strategies you might consider, to make saving for a deposit easier:

The Fixed Interest Approach: Through serious consideration of your current spending habits and careful budgeting, you may be surprised at just how much you can save. Is that coffee on your way to work really necessary? Or, could you perhaps make one at home and pop it in a travel mug? Is the Diet Coke you purchase each time you fill up your car really worth it? ASIC’s Money Smart has a useful budget planner which could help you develop a personalized budget. Alternatively, we offer an app which data-feeds your bank transactions and can track your spending in real time. If you are interested in learning more about this, please contact us.

Bear in mind that careful budgeting and strict discipline go hand in hand. If you find yourself spending everything you earn, it might be a good idea to open a high interest savings account with low fees. Each time your pay is deposited into your everyday bank account, your first priority should be to transfer your allocated savings straight into that high interest savings account, and leaving it there. You could even set up an automatic transaction so you don’t have to think about it.

Please carefully read the Product Disclosure Statements before opening any new accounts. High interest savings accounts may incur a fee if more than one withdrawal is made per month, and in some cases, you may lose your high interest rate for that month if withdrawals are made.

The Investment Approach: If you don’t mind a little bit of risk and aren’t expecting to purchase a home in the next few months, this could be a viable option to consider. Investment strategies such as Dollar Cost Averaging (DCA) can dramatically increase your wealth over time. The purpose of this strategy is to reduce market timing risk. This essentially means that you are avoiding purchasing a lump sum of units at their peak price, but rather investing gradually over time to average out the price per unit.

The below table illustrates the benefit of Dollar Cost Averaging when $100 per month has been invested over a 12-month period.

Month Amount Invested Unit Price ($) Units Purchased
January $100 40 2.5
February $100 38 2.6316
March $100 35 2.8571
April $100 39 2.5641
May $100 37 2.7027
June $100 38 2.6316
July $100 35 2.8571
August $100 34 2.9412
September $100 36 2.7778
October $100 35 2.8571
November $100 39 2.5641
December $100 40 2.5
Total $1,200 32.3844

 

Total Amount Invested:                    $1,200

Total End Value:                                   $1,295*

Gross Capital Gain:                             $95

*Total Units Purchased X End Value Per Unit (rounded)

At the end of the investment period, the investor has increased their portfolio value by $95 without the unit price ever increasing more than the starting price.

 

Dollar Cost Averaging could be a suitable strategy for those who may have a tight budget or for those that are in no rush to get into the property market but are aiming to own their own home one day. However, it is important to understand the type of portfolio you are investing in.

Typically, balanced investors will let their portfolios grow for a minimum of 3 years before withdrawing any funds. On the other hand, those who are investing in more growth type assets (such as international shares) tend to let their portfolio grow for a minimum of 5-7 years before withdrawing any funds. The purpose of these time frames is to allow the investments to run their natural course.

It is important to clearly understand your tolerance towards risk before considering this strategy. To discuss this strategy in further detail, contact Future Key Financial today.

Disclaimer

Please note, this is general advice only and does not take into account your personal circumstances. If you would like to find out the best strategy for you, or if you would like some extra tips, contact Future Key Financial today.