Buying a property is the biggest financial purchase any of us will ever make. When going down this path you need to be educated about all the things that are important to consider so that you make the right decision. If you get this purchase wrong, it can be a very expensive mistake and lead to a lot of financial pain.
In this blog I am going to outline 5 things you need to know and consider before buying a property to ensure you make the right decision and have your finances set up in the right way for the purchase, so that it doesn’t lead to years of financial pain.
1. The location of your property is going to be the main contributor to the capital growth of your property
Now this is nothing new for most of you and probably almost seems too simple to even warrant talking about it. But it is worth going over because it is such an important factor when purchasing a property – be that either a home or investment property.
When considering where to buy your home usually you will buy in the area where you want to live and this will be the main factor when making your property selection. But some questions to ask yourself about the location when making your decision on where to buy are:
- What schools are close by?
- How close is the property to shops?
- What sort of work and employment opportunities are close by?
- What are the public transport options close by and how far away are they?
The reason these are important when purchasing a home is not only because they will make living in your property more enjoyable and easier while the property is yours but they will also help contribute to the long-term capital growth of your property. This will be very important if this property is not going to be your forever home and will need to be sold one day.
When purchasing an investment property these factors become even more important. This is because you are buying a property for someone else to live in, it needs to suit them not you. Considering all of the questions outlined above and making sure that your investment property is close to all of the these, will make your property more appealing to a prospective tenant and will help with the capital growth prospects of your property in the future.
2. Your deposit matters
The amount of savings and deposit you have to contribute to your purchase will have a huge impact on your finances and the type of loan you end up with. Wow thanks Ryan, really?
Please hear me out. I am focusing on this point because if you need to borrow more than 80% of the value of the property you are buying (e.g. if you are buying a $1,000,000 property and if you need borrow more than $800,000) the bank will slug you with lenders mortgage insurance (LMI).
LMI is an insurance policy that the bank takes out to protect them in the event you can’t afford the repayments on your loan anymore. The bank will take the policy out to protect them but they are going to make you pay for it!
Because of this, you need to be aware of it and understand how expensive it can be. For example, if you wanted to buy a $1,000,000 property and you had a 10% deposit ($100,000 deposit) the mortgage insurance premium payable on the purchase would be $22,320! Even worse is if you wanted to buy at $1,000,000 and you only had a 5% deposit ($50,000), the mortgage insurance on the purchase would be $46,930!
As I said above your deposit REALLY MATTERS and the mortgage insurance amounts I have illustrated above demonstrate why!
3. There are more costs involved in the purchase than just your deposit
When sitting down and doing your numbers with your mortgage broker for your property purchase you need to realise that there are more costs involved with your property purchase than just getting your deposit together. You will need to make sure that you factor in these other costs when considering your property options, so that you don’t get caught out financially.
The other big expenses that you need to factor into your numbers include:
- Stamp duty – which will usually be your biggest expense outside your property deposit. Using our $1,000,000 property purchase price example – the stamp duty on this property will be $40,719 (for a property in NSW).
- Conveyancing fees – when purchasing a property you will need a conveyancer to assist with the property transfer for you from the current owners to you. The cost of a conveyancer can range between $1,000 – $2,000.
- Bank fees – there may be establishment and/or settlement fees that the bank charges for your property purchase that will need to be paid. As an estimate this can range anywhere from $0 – $1,000.
- Property reports – depending on what property you are looking to buy. You will usually need to arrange a property report before the purchase to make sure you are buying a good property and that there is nothing wrong with it. This would normally be a building and pest inspection report for a house purchase and a strata report for an apartment. These reports can range from $50 – $1,000 for a more comprehensive property report.
The above list are all of the pre purchase costs that need to be factored into your numbers before working out what sort of property you should buy. We would normally suggest that clients factor in needing approx. 5% of the purchase price for the costs associated with their purchase. This figure is on top of the deposit they need for the purchase. So using our $1,000,000 example again, this would be budgeting approx. $50,000 for the costs to buy at this level.
On top of the pre purchase costs discussed above, there are a few forgotten costs that people forget to consider when purchasing a property and doing their numbers. These costs are more relevant when you are purchasing a home rather than an investment property but if not considered and factored into your purchase, they can leave you short financially.
These forgotten costs include the removal costs that will be associated with getting into your new property, as well as the property set up costs once you have moved into the property. These “forgotten costs” in particular the property set up costs can end up being quite large and may involve – painting the property, purchasing new furniture and decking out the property and doing small renovation’s on the property before moving in.
This is a big list of expenses and we have not put these in here to scare you, but to help you prepare financially for your property purchase. We are hopeful that by educating you on all the costs that you need to consider when buying a property that you will have money available to pay for them and don’t get caught out financially by missing them when doing your numbers for your property purchase.
4. Don’t go TOO big!
Buying a property is a very emotional experience. When you are looking to buy you can be tempted to borrow more than you should, to be able to get the biggest or best located property that you can.
The banks are happy to help here and love to lend money to us because this means more money in interest through loan repayments for them. Now this works out to be great for the banks but may not be so good for you or me. If rates start going up during the time that you own the property, your repayments will also start going up which means that your monthly repayments are going to start chewing further into your monthly budget.
This could mean that you have less money to put towards your savings, goals and/or investments each month. Or if things were already tight financially, this can mean you get yourself into “mortgage stress”. This is where your monthly mortgage repayments get so high, that it reduces your ability to pay your bills and other living expenses. Which means you have to look at cutting expenses in other areas of your life – recreation, entertainment, your weekly grocery spend etc.
At the time of writing this blog in mid 2020 interest rates on mortgages are around 2.2% up to 3.5% at the higher end of things. These interest rates are the lowest in history, which is an awesome thing for anyone with a mortgage. At some point though this will change and interest rates will go up again. What you need to ensure is that you will have the money to be able to absorb these future rate increases. Because it is very easy to get used to interest rates at the very low levels they are at. But ask anyone who has owned a property for a while and they will tell you that this is not normal and at some point, rates will have to go up again.
The best strategy when it comes to planning your numbers for a property purchase is to look at what you can afford to pay in mortgage repayments each month and use that as a guide to determine how much money you should borrow for the purchase rather than going off how much money the bank will lend you based on your current income. It is likely that the amount the bank is willing to lend you, is going to be a much bigger figure than what you will come up with after reviewing your monthly repayment capacity.
We normally talk to clients about aiming for a mortgage repayment that is no more than 30% of their take home income each month. This usually ensures that they are in a position to pay for their mortgage, all of their other living expenses each month and ideally have money left over to save and invest.
We would also aim to make sure that our clients have the ability to still afford their mortgage repayments if interest rates were 2% higher than they are today, without it having a big impact on their monthly finances. If we run the numbers and they can’t do this, we would tell them that they need to reduce the loan they are looking to take out, to make sure they are protected financially.
It’s great to be able buy a property and achieve the “Great Australian Dream”, but if you go too big and borrow more money than you can afford to repay, you can get yourself into mortgage stress. This financial stress can lead to stress in other areas of your life – your job, your relationships and maybe even your health.
So, when looking to buy a property, don’t go too big! Run your numbers and work out what you can afford in repayments each month before working out how much money you will borrow. Then make sure you can still afford those repayments if interest rates were 2% higher than they are now while trying to make sure that these repayments don’t exceed 30% of your take home pay each month.
5. Cover yourself by having a safety net
I have spoken about this in another blog post but it is definitely worth repeating again here. If you are going to go out, borrow a large amount of money and commit to a 30 year relationship with a bank – do yourself a favour and make sure you have a safety net in place (after the purchase).
We would suggest 3-6 months of your mortgage repayments in cash to cover any unforeseen circumstances that life may throw at you. This will ensure that you and your family are still able to maintain your mortgage repayments should something happen to you and you can’t work for a few months. These unexpected events could be losing your job, an unforeseen illness or in the current environment, not being able to work because of a global pandemic!
What this safety net does is ensures that you don’t have to stress about money or your mortgage repayments for a period time, when bad times occur (and they always do).
It is a smart, safe, risk free way to protect your family and your biggest asset!
There is a lot of information to take in from this blog post. However, we are hopeful that what we have outlined above will help you to buy smartly and safely when you look to purchase a property. This information will allow you to be fully prepared financially, when you make the decision to join the property market and make the biggest purchase of your life!
Ryan Porter is a Wealth Coach at Catalyst Wealth Group. His mission is to help his clients achieve financial success and live their ideal life.
Any advice or information in this publication is of a general nature only and has not taken into account your personal circumstances, needs or objectives. Because of that, before acting on the advice, you should consider its appropriateness to you, having regard to your objectives, financial situation or needs.