Entering the Property Market
The homebuying process is complex and first home buyers can be manipulated by unscrupulous real estate agents, property marketers, and lenders. From experience, our clients want to help point their family in the right direction when buying their first property rather than leave them to go it alone. This article addresses many of the issues a first home buyer needs to consider.
House prices
Australia is a great place to live. Our cities are mostly safe, multi-cultural, and our weather is pretty good (except for Melbourne). However, it’s fair to say the secret is out. Australia is expected to import more millionaires than any other country in the world in 2023[1]. Calling Australia home, and having a home in Australia, is clearly appealing.
One of the biggest financial transactions people make in their lives is buying a property. While we don’t suggest that residential property is always a rational market, property pricing still comes down to simple economic theory of supply and demand. Property pricing is influenced by several factors:
SUPPLY
The number of properties available, through construction and new builds.
The number of properties being sold.
DEMAND
Interest rate changes, which impact borrowing capacity and the ability to service a mortgage.
Local changes to an area such as increased amenity (restaurants / schools / parks), any kind of infrastructure (public transport / roads) that improve an area, these growth drivers will naturally increase the demand to live in an area. The change in demographics is known as gentrification, a classic example of gentrification in Sydney is with the suburbs of Bondi Beach and Redfern, where 20 years ago they were less than desirable areas and are now highly sought after areas to live with high property prices.
Not all suburbs experience the same price growth over time. Some suburbs are more aspirational than others, which helps support prices. But house prices can be just as volatile as share markets – you just don’t always feel the change in prices.
We recommend reading this article as a reminder house prices do not only go up - https://loricapartners.com.au/insights/2019/4/29/sydney-residential-house-prices-vs-share-portfolios-e7yrg . In 2022, it was estimated Sydney house prices fell 10.9%.
Where to buy
This can be a challenge for many clients’ children. Having grown up in desirable parts of Sydney, naturally this is where many children want to buy. But these are often expensive areas, and our clients’ first property purchases were often not in the suburb they now reside in.
If the desire is to buy in an affluent area, then rentvesting may be appropriate. This means rather than living in your first home, you rent it out as an investment property. This may allow you to live where you want to live (as a renter) but you cannot afford to buy as a tenant. It also means many costs become a tax deduction.
The bank of mum and dad
Between 40% and 55% of Australians receive financial assistance from their parents to purchase their first property, primarily to help pull together the deposit and cover the stamp duty.
It is important to consider how any financial assistance is provided.
If the funds are a gift, then the bank will include them as part of the deposit. However, asset protection may be lost. To confirm it is a gift, most banks require a letter or statutory declaration from the parents.
If the funds are structured as a formal loan, then the bank will reduce the value of the parental loan from total borrowing capacity. For example, if the bank estimated they would lend $1,000,000, and the parental loan is $250,000, then the bank will reduce the amount they are willing to loan to $750,000.
It therefore becomes a big decision on how you provide financial assistance to children. We recommend you talk to your adviser.
Applying for a mortgage
When you apply for a home loan, the bank’s credit department will focus on two areas:
Loan to Value Ratio (LVR) – the size of your deposit relative to the value of the property. If the LVR is above 90%, mortgage insurance (an additional cost) is typically required. Banks often provide sharper pricing when the LVR is below 80%.
Serviceability – an assessment of your ability to meet the monthly payments for the loan, especially if interest rates are higher than current levels. Banks spend a lot more time focusing on this than they did 10 years ago. Not only will you be required to provide a comprehensive budget, but banks often vet your figures against actual spending – expect your most recent credit card statements to be scrutinised.
If you are not sure where your money is going at present, you will struggle to service a loan.
Print out the last month’s transaction history from your everyday bank account and highlight your spending. Consolidate your non-negotiable spending: rent, mobile plan, internet, utilities, transport, groceries, and insurances. Look for areas where you can decrease spending: uber eats, entertainment, clothing, impulsive purchases. Track yourself over the next month and see how you went - any surplus can go towards a deposit or repayment on a loan.
You need your spending behaviour to be ready for the discipline of having a mortgage before you purchase the property. If you don’t, the risk of parents being called upon for financial assistance in the future increases significantly.
We recommend first home buyers use a mortgage broker to help guide them through the extensive loan application process and to ensure they are considering multiple banking options. Lorica Partners has fantastic mortgage brokers we collaborate with for our clients and their families. We can arrange an introduction – please ask your adviser.
First home buyer incentives
State governments provide incentives to first home buyers – primarily through a reduction or avoidance of stamp duty – but there are thresholds. In NSW for example, from July 2023 there is a full stamp duty exemption on new and existing homes valued up to $800,000.
These incentives are constantly changing, so you need to review what is available at the time you are ready to purchase. This is the site for NSW residents - https://www.revenue.nsw.gov.au/grants-schemes/first-home-buyer/assistance-scheme
All Australians have access to the First Home Super Saver Scheme. The scheme allows you to save up to $15,000 per year up to a maximum of $50,000 across time. You can only withdraw voluntary super contributions – not employer contributions made as part of compulsory employee super contributions. You also need to occupy the property for at least 6 months of the first 12 months you own it. Two individuals can access their own super funds to jointly buy a property.
Understand the costs involved
The ideal security is a deposit of 20% of the purchase price, however, you can obtain lending with as little as 0% deposit, should a parent go guarantor.
It is a privileged position to have parents willing to support a child as guarantor. It is not available to everyone, nor is it appropriate for everyone. The guarantor is responsible for paying back the entire loan if the borrower cannot. Considerations of the relationship between parent and child should be made before entering such a union. Prima facie it is not a strategy we recommend to clients.
Costs your deposit will need to cover include:
Stamp duty – circa 5% unless first home buyer concessions apply.
Legal conveyancing costs – circa $3,000
Building or strata reports
Mortgage insurance if borrowing 80% to 90%+ of the purchase price.
Registration fees
Loan application fees
Moving costs
Then there are the ongoing costs which include:
Council rates
Utilities like water (landlords pay water rates for apartments)
Strata fees for apartments, typically paid quarterly.
Insurance like building and contents or landlord insurance. For apartment owners, building insurance is normally included in strata fees.
Maintenance, including the occasional special strata levy for apartment owners.
Think long term
FOMO (fear of missing out) causes a lot of buyer mistakes. So too does the tedium of weekends spent looking at properties and the pressure of auctions.
Overpaying is one of the biggest mistakes first home buyers make because the emotion and excitement of being a homeowner takes over. Be patient.
If you need your money back in 0–5 years, consider not buying property because the entry costs (5%+) and exit costs (2%+) are steep. A fixed interest and/or equity portfolio is likely a better option.
Your Lorica advice team is happy to speak with our clients, or directly with their children, to help navigate the process of purchasing a first home.
Current Market Conditions
Domenic Corigliano, a mortgage broker we collaborate with, recently provided the following insights on the current state of the Australian bank lending market:
Lenders apply an assessment rate when looking at serviceability, which usually sees a buffer of 3% above the actual rate. In recent weeks we are seeing more and more lenders review this ASIC requirement, dropping it to 1-2% above actual, based on meeting certain criteria – namely no increase in debt, P&I repayments, new commitments being less than current. This drop in the assessment rate should make it easier for more lenders to refinance.
The so called “fixed rate cliff” is also starting to rear its head, as 2 year fixed rate loans taken out in 2021 are starting to expire. Over the next 12-18months, these lenders will roll out of a 1.99-2.5% fixed rates into 6.5-7% variable rates. The options available to these lenders are limited, so it’s a matter of seeing what is the best variable rate they can achieve at their own bank, refinance out if better rates exist and/or look at what fixed rates are available.
Until recently short term fixed rates were very attractive (some lenders still are) with 2 and 3 year fixed rates in the mid 5’s – as compared to a variable rate in the high 5’s / low 6’s – with the risk of them going higher. We had a number of clients opt for a 1 year fixed with the view that if the market continues to weaken over that period; yes we may start to see rate cuts (mind you I think any proposed rate cuts in the future will be nominal, and more symbolic rather than having a large impact) but we may see new fixed rates at that time at much lower levels, reflecting where they think rates are heading.
Authors: Christie Britten & Rick Walker
[1] Private Wealth Migration 2023 | Press Release | Henley & Partners (henleyglobal.com)