Strategy Talk | November 2018
This month we’re (strategy) talking property - a hot topic in recent months. Are you thinking of downsizing? Are you looking to buy? Do you dream of owning a holiday house? We explore a range of factors to consider before making such a big decision. All this and more, in this month’s edition of Strategy Talk.
DOWNSIZE YOUR HOME, UPSIZE YOUR SUPER
Over 65? Thinking of selling your home? Since 1st July 2018 you may be eligible to contribute up to $300,000 ($600,000 for a couple) from the proceeds of the sale of your home to your superannuation fund.
This incentive, known as the ‘downsizer contribution’, is part of a federal government program to improve housing affordability. It offers a further opportunity for some home sellers to benefit from the tax advantages associated with superannuation. On the downside it may adversely affect eligibility for age pension.
Rules apply
Of course, it wouldn’t be a super contribution without lots of rules, and the main ones are:
You must be 65 or older when you make the contribution. This could affect decisions on the timing of a sale. For example, Anne (67) and Rod (63) are thinking of downsizing. As only Anne can make a downsizer contribution they may want to delay selling their home until Rod turns 65 so he can also make one.
You or your spouse must have owned the home for at least 10 years prior to sale; it must be your main residence; and cannot be a caravan, houseboat or mobile home.
You can only use this concession once. You can’t use it with subsequent home sales.
The contribution is limited to the lesser of $300,000 each or the total proceeds from the sale of the home. In the case of couples, contributions don’t need to be evenly split. Take Tom and Stephanie. They sold their house for $500,000. Rather than contribute $250,000 each, Stephanie contributes her $300,000 maximum. Tom’s downsizer contribution must then be no more than $200,000.
The contribution must be made within 90 days of receiving the proceeds, though an extension may be granted in limited cases.
Curiously, given the name of this initiative, you don’t need to physically downsize your home. If you have the funds available you could buy a bigger or more expensive abode. In fact, you don’t even need to buy a new home at all.
The effect on super
On the superannuation side, you can make a downsizer contribution if your total super balance exceeds $1.6 million. However, the contribution will count towards your transfer balance cap (i.e. the cap on the amount you can use to establish a tax-free superannuation pension). Even so, it may still be advantageous to hold these funds in the concessional (15%) tax environment applicable to the super accumulation phase.
And what about the age pension?
Anyone thinking of downsizing needs to consider the impact on eligibility for age pension. A main residence is exempt from the assets test, but if its sale frees up money – for example through buying a cheaper home or renting – those funds will be assessed under both the income and assets test even if they are used to make a downsizer contribution. This may result in a reduction or loss of age pension.
The extent to which you can benefit from making a downsizer contribution depends very much on your individual situation. And it isn’t just a financial issue; lifestyle considerations are also important. Before making a decision it’s important to consider all the angles, so talk to us about whether a downsizer contribution is right for you.
EVERYTHING YOU WANTED TO KNOW ABOUT BUYING A HOME
Ready to make the leap from renting to buying a home? Well, before you begin the search for your perfect home there are lots of questions to ask yourself. Here are some of the big ones.
Do you need to own your home? For most people home ownership remains part of the great Australian dream, but that’s changing. Renting offers greater flexibility and can be an economically viable alternative to buying. Weigh up the pros and cons first to see if you really want or need to own your home.
If the answer is a definite yes, then…
What repayments can you afford?
To answer this question with certainty you really do need to do a budget. This should show you exactly how much money is coming in, how much is going out, and how much is left to service your mortgage. Your budget will identify what you are spending money on and may reveal areas where you can save more. If your plans include starting a family at some stage, factor in the likely drop in income.
How much can you borrow?
Once you know how much you can spend on mortgage repayments you need to work out the size of the mortgage these repayments will support.
Plug your repayments into the mortgage calculator at moneysmart.gov.au. Use an interest rate of at least 7% per annum. While you may be able to borrow at a much lower rate, and therefore afford a larger mortgage now, banks are required to check that borrowers can comfortably service their loan if there is a significant rise in interest rates. The figure currently set by the government regulator (APRA) is 7%, but some lenders use even higher figures.
What’s it really going to cost?
Aside from the purchase price, buying a home comes with a whole lot of other costs, some upfront and many ongoing.
Stamp (or transfer) duty is usually the biggest of these. Remember to allow for it when setting your purchase limit. Conveyancing, loan establishment fees and removalists are other up-front costs.
Buying an apartment or unit? Annual body corporate fees need to be funded. These, along with other ongoing costs such as council rates and insurance premiums must be included in your budget.
If this purchase will be your first home, check out details on first home buyer grants in your state or territory here firsthome.gov.au. Stamp duty concessions may also be available. Combined, these initiatives can save you tens of thousands of dollars. Make sure you understand the conditions that apply, such as limits on the value of the property. If eligible for a grant, factor this into your calculations.
What deposit do you need?
While you may still find lenders willing to loan up to 90% of the value of a property, 80% is a more likely and sensible limit. That leaves you to come up with 20% of the purchase price plus upfront costs.
Have you saved your deposit, or do you still have some way to go? If the latter, review your budget to see how much you can save. Then set some savings goals and document how you will achieve them.
What’s your savings record?
Your lender will want to see your bank account and credit card statements. Do they reveal a good savings history and responsible use of debt; or the habits of a reckless spender with a poor credit rating? If it’s going to take awhile to save your deposit, it’s not too late to build a good savings history that will impress your lender.
Try to clear current debts as quickly as possible. Cancel any unnecessary credit cards, and consider cutting back the spending limit on other cards. When you apply for a mortgage your lender will include your credit card limits, not the actual balances, in their calculation of your current debt.
Do you know how mortgages and interest rates work?
If not, do your research. Get as much information as possible from the lender, with details of all the fees that apply – including any early repayment fees (yes, you can be charged for paying off your mortgage early!). If the loan comes with any ‘sweeteners’ or other features, make sure you understand them and any potential costs. Understand comparison rates and their limitations.
Aside from the purchase price, the biggest influence on how much your home will eventually cost you is the interest rate. On a $400,000 mortgage at 4% per annum over 25 years with monthly repayments (and ignoring fees), you’ll end up repaying a total of $633,404 of which $233,404 is interest. At an interest rate of 7% that interest bill rises to $448,135![1]
Fixed or variable?
Your lender may offer you the opportunity to fix the interest rate on at least a portion of your loan for up to five years. A fixed rate will be an advantage if interest rates rise. If they fall, you’ll end up paying more interest than if you opted for a variable rate on the entire loan. Investigate the option of splitting your loan between variable and fixed rates.
Interest rates tend to rise when the economy is strong, unemployment low and the inflation rate is increasing. They tend to fall when the opposite conditions prevail. That said; it’s extremely difficult to predict future interest rate movements. Should rates fall, you may face significant fees on any early repayment of the fixed component of your mortgage.
How can you reduce your interest payments?
Your interest is calculated on your outstanding loan balance, so anything you can do to reduce that balance will help reduce your total interest bill. Many loans offer a linked 100% offset account. The balance in your offset account is subtracted from your outstanding loan amount when the interest is being calculated. It therefore makes sense to keep as much of your spare cash as possible in your offset account.
As financial circumstances allow, you can also increase your mortgage repayments to pay off the loan sooner. Using the previous example of a $400,000 loan at 4% interest, if you paid it off in 20 years rather than 25, the interest component would be only $181,741, a saving of more than $51,000.
Another option is to make fortnightly or weekly repayments, rather than monthly.
Ready to buy?
Be aware that it is now more difficult to get a loan due to lender and regulator concerns over high levels of household debt. However, there are still plenty of lenders to choose from, including your current bank, other banks, non-bank and online lenders. It can pay to shop around, whether you do it yourself or use a licensed mortgage broker.
When it comes to applying for a loan be prepared to provide your lender with pay slips, credit card and bank statements, and details of your assets and any debts you have. Then, before you start visiting open houses, consider seeking pre-approval from your intended lender. Be aware that pre-approval may not guarantee that your loan application will be successful, particularly if it’s an instant appraisal based solely on the information you provide. Check with your lender what their pre-approval actually means. If it’s a full assessment it will provide you with more certainty when making an offer. Even then, pre-approval may not protect you if, say, the property is unacceptable to the lender. Also be aware that making multiple pre-assessment applications can affect your credit rating.
Do you understand everything, including all the fine print?
If not, ask questions and seek independent advice. Never, ever, sign a blank form. Make the right decision the first time. The costs of switching lenders can be high.
What insurance cover do you need?
You’ll obviously insure the house and contents, but what other insurance cover do you need? With your ability to make mortgage repayments dependent on you earning an income, income protection insurance should be a high priority. Life and disability insurance should also be considered. And yes, the premiums all need to be included in your budget calculations.
Need advice?
Buying a home is one of the biggest financial steps you’ll ever take. It’s also a complex process, and seeking good financial advice right at the start of the process can deliver rewards down the track.
When the ink is dry it’s time to crack that bottle of bubbly and celebrate getting your foot in the door of home ownership.
THE HOLIDAY HOME ROMANCE
We all know the feeling. The sun is shining, the waves are lapping peacefully on the shore, there’s a cool ocean breeze wafting gently through your hair and the crisp sand is etched between your toes.
Sometimes you wish your holiday romance could last forever.
Technically it could!
Hundreds of thousands of Australians own their holiday getaways. With the temptation to escape the daily grind, a holiday home can be a very rewarding purchase.
But do holiday homes make a good investment?
When it comes to investing in property, it’s easy to let your emotions rule. However, before you make any snap decisions you should consider the benefits and risks associated with this kind of purchase.
The benefits
Free accommodation when you go on holidays.
You will have a home-away-from-home with unlimited access (depending on tenancy arrangements).
You can rent your holiday home out for the portion of the year that you don’t intend on staying there to help mitigate some of the costs. This can be particularly beneficial during peak seasons.
Your holiday home may increase in value over time. The potential for capital growth on property investments is generally higher than that of cash and fixed interest investments depending on the property.
You can claim a tax deduction for expenses incurred in maintaining your holiday home for the period of time it is rented out.
The risks
Occupancy rates fluctuate. Strong demand for holiday homes is on average around 8 to 10 weeks per year – and this is dependent on location. Demand for homes in a warmer climate is more consistent (especially if it’s beachfront).
If you rely on income from peak holiday seasons you won’t be able to use your holiday home during these times, e.g. during school holidays.
You may need to take on a significant mortgage as holiday homes can be quite expensive.
On top of the initial purchase price you will also need to consider the costs of maintaining the property, including management fees.
Any rental income or capital gain that you realise upon redemption of your holiday home will be added to your assessable income and taxed at your marginal rate in that financial year.
If there is a property market downturn, holiday areas are generally the first to suffer and the last to recover. If you have chosen an area, do thorough research on past cycles and how they have affected local prices.
You might get bored visiting the same place over and over. On top of this, you may even feel guilty if you holiday somewhere else!
Investing in any type of property is a big decision. When considering purchasing a holiday home, you should try and think a little less with your heart and a little more with your head. Seek professional guidance before making any big decisions.