Buying your first home – Part 1 of 2

Let’s settle the age old debate. Home ownership or smashed avo and bottomless mimosas? Young Australians are becoming more frugal these days and it excites me to say that financial literacy is improving. However, home ownership rates in Australia reached an all time low in 2016 and unfortunately, this trend is getting worse. But we’re a financially savvy bunch, so let’s talk about the steps you can take towards one day owning your own home. This article will be split into two parts. Part 1 will cover your deposit and your borrowing capacity and part 2 will cover government concessions put in place to help first home buyers, as well as the investment aspect of home ownership. Now, without further ado, let’s make fun of birkenstocks.

Deposit

This is your biggest hurdle. In most cases, Australian banks will not be willing to finance a mortgage without tacking on LMI if your LVR is over 80%. Let’s deal with the jargon:

  • LMI stands for lenders mortgage insurance. Generally speaking if you default on your mortgage (are unable to pay your mortgage repayments), the bank will exercise what’s creatively called a ‘power of sale’ on your property. Let’s say you have an outstanding amount owing on your loan of $650,000. Let’s say the bank sells your property for $600,000. The difference is called a shortfall. If the bank has required you to take on LMI, the bank can call on the insurer and claim the shortfall. The insurer can then come after you. I have my personal views on LMI, but I’m not allowed to share them. Because laws. So I won’t. Something I’d love for you to commit to memory however is that despite the fact that you’re responsible for paying the premium on your LMI, LMI does not provide you with any protection. It only protects the bank.
  • LVR stands for loan to value ratio. Let’s say your property is worth $600,000. Let’s say you’ve saved a deposit of $180,000. You will need to borrow $420,000. Your loan is $420,000, your value is $600,000. Therefore, your LVR is 70% – you probably don’t need LMI. If you’d only saved $60,000, your LVR would be 90% and you’d likely need LMI.

It’s up to you to decide whether you should jump into the property market sooner with an insufficient deposit and take on LMI or to put off buying until you’ve hit 80% LVR. Your decision will typically come down to how much you think the property you’re after will appreciate in value in the time it’ll take you to save to 80% and whether that amount exceeds the LMI you might pay now. You should also note that if your LVR is over 80%, the bank may deem you to be at higher risk of default and therefore might apply a higher interest rate to your mortgage. We talk more about this when we look at the Australian Federal Government’s controversial First Home Loan Deposit Scheme in Part 2.

Borrowing capacity

Here’s your next pain in the neck. Your borrowing capacity will depend on everything from how frugal a person you are, to what your assets and liabilities (including credit card limits) are, through to what APRA (the Australian Prudential Regulation Authority) feels like doing on any given day. The bank will scrutinise (or at least say they will until they apply the Household Expenditure Measure) your accommodation expenses, transportation expenses, entertainment expenses, your healthcare expenses, your credit card limits and credit spending history, your HECS repayment obligations, other outstanding debts such as personal loans or other mortgages, and your credit score.

Even if a lender’s rates are as low as 3%, the lender will likely assess your ability to service the loan at a much higher rate, such as 6%. This is because your lender has to account for interest rate hikes. You’re taking on a mortgage on the presumption that you’ll pay off the loan over a 30 year period. A lot can happen in 30 years. 30 years ago Google didn’t exist, the Berlin Wall was still standing, Latvia’s independence was not yet recognised and your favourite smashed avo enthusiast was yet to be born.

Don’t be salty if those darned capitalists won’t lend you enough money for that trendy 3 bedroom terrace in Paddington, Sydney. This is a post-GFC era and banks are required to comply with responsible lending criteria. Plus, banks are businesses. They exist to make money and so they depend on you actually being able to service your loan. Defaulting is a lose-lose scenario in most cases.

Borrowing as a couple might at first come across as more appealing. And in a lot of cases it is. Your combined income is higher and therefore, so is your borrowing capacity (potentially). However, so are your expenses. Further, this will also mean that there will (in most cases) be two names on the title and two names on the mortgage. Obviously no one wants to assume the worst but property is a long game and a savvy first home buyer/investor does his/her due diligence and accounts for all risks. Never forget to factor in the risks associated with a split. Most people will sell their property and part ways during such unfortunate events and selling your property prematurely can cost you large profits or incur taxes you might not be ready to incur.

I like sipping cauliflower lattes, do I have to change up my trendy millenial lifestyle?

It depends. If you have so little respect for the public that you’re willing to offend everyone’s eyes with a pair of birks, then yes, please change up your lifestyle. If you’re dropping $179 to look like you attended the last supper (not my joke but it’s so on point), you need help. For everything else, don’t let a baby boomer who went to university for free tell you how to live your life and just be rational about how you manage your finances. Let’s talk about some biggies:

  • Housing: If you live on the east coast of Australia, I’ve got some bad news for you… Renting sucks if you’re trying to save up a five or six figure deposit and unless you’re willing to move back in with your parents for a year or so, there’s not much I can do for you here. But let’s misappropriate a Muhammad Ali quote – “I hated every minute of [living in Western Sydney (it’s okay, I live here, I can make this joke)], but I said, don’t quit. Suffer now and live the rest of your life [in Inner Western Sydney].” Wherever you live, housing will be your biggest expense. Being frugal about your living conditions and making concessions here will make the biggest difference on your deposit. Your future self will also thank your present/past self when the bank is assessing your borrowing capacity.
  • Transportation: A friend once called me a loser for not owning a car. Not owning a car to her meant that I was sacrificing freedoms she wasn’t willing to go without. And that’s fine. Everyone’s circumstances (and in this case preferences) differ. But I put it to you, if public transport will get you there, just take the freaking train. I’m sorry auto industry but you cost purchase price, interest, rego, CTP, insurance, maintenance, depreciation (and therefore awful salvage value) and about 100 crap loads of carbon emissions. This will put a dent in your savings and (hopefully) your conscience (sorry, environment above all else).
  • Entertainment: Do you need to cancel your Netflix subscription? Up to you. But consider that the average membership costs $14 per month. A movie ticket costs more than a whole month’s worth of Netflix… You do the math. Do you need to cancel your Spotify subscription? A ticket to a single gig will likely cost you a year’s worth of Spotify. Pick your battles friends.
  • Clothes: Again, please rethink everything if you’re strutting around Newtown looking like you’re about to ‘find yourself’ on a gap year in Mykonos. Otherwise, be sensible about it. It’s not the end of the world if you wear the same suit twice to work in the same week, or if the same pair of shoes show up in more than one Instagram post.
  • Social life: Chances are if you’re saving up a deposit for a home loan, your social life has taken a bit of a back seat. The bank will likely ask for statements going back one year, so keep that in mind before you start booking expensive tickets to music festivals or upgrading that 720p TV.

You just said I shouldn’t let someone tell me how to live my life. What gives.

The above are just some examples you should be keeping in mind. Just as we acknowledged with the transportation example that everyone’s circumstances differ, it’s important to appreciate that not everyone will have the privilege of being able to forgo some of the things we just discussed. As much as I’d like to encourage as many people as possible to read this blog and take control of their finances, I also understand that not everyone has the same interests or desires that I have at this point in time. Stay tuned for the more interesting Buying your first home – Part 2 article.