Purchasing your first home is an important decision with far-reaching implications. You’ll be significantly better off financially if you make the right choice. However, if you mess it up and buy the wrong property, you could be worse off both financially and from a lifestyle perspective.
Many parents have learnt a lot from their experiences, both positive and negative, and seek to pass on these insights to their children to guide them in making informed decisions.
The goal of this blog is to offer my best advice to first-time homebuyers and their parents.
Buying well is critically important
When it comes to choosing a home, lifestyle preferences often take precedence over financial considerations. However, as I’ve emphasised in a recent blog, adopting an investment mindset when approaching your first home purchase can lead to significant long-term financial advantages.
In this blog, I outline how to acquire the highest quality property within your budget. Essentially, it boils down to three crucial attributes: (1) identifying areas with a consistent supply-demand imbalance, (2) analysing past growth, and (3) spending most of your money on land value.
It’s essential for first-time buyers to be realistic. Securing a property in their ideal suburb might not always be feasible. Instead, they may need to compromise initially and purchase a property that meets basic liveability standards but provides good growth prospects. This can serve as a foundation for building equity to use as a stepping stone to get into their desired location, as discussed here.
The objective is to invest in a first home that experiences significant capital growth within the initial 5 to 10 years of ownership. This equity can then be leveraged to upgrade or as an investment.
Government support available
There are numerous grants, schemes and assistance offered to first-time buyers by the state and federal governments.
The First Home Super Saver (FHSS) allows first-time buyers to use their super account to accumulate up to $50,000 of savings for a property deposit. This can be achieved by making additional (concessional) contributions into super i.e., in addition to compulsory employer contributions. The benefit is that these contributions are tax-deductible and investment earnings are only taxed at 15%. For example, someone earning $145,000 who wants to save $10,000 per year could make $10,000 of personal concessional contributions into super. This $10,000 would be taxed at 15% instead of the marginal rate of 39%, meaning the saver will have $2,400 more to contribute to a property ($3,900 versus $1,500).
The federal government offers a limited number of guarantees under its Home Guarantee Scheme (HGS). This means first-time buyers only need a 5% deposit and they can borrow the remaining 95% without paying for Lenders Mortgage Insurance because the government provides a guarantee. Lenders Mortgage Insurance is a once-off cost charged by lenders if you borrow over 85% of a property’s value. It is quite expensive and can cost 3% to 4% of the loan amount, so the HGS provides huge savings.
State governments typically offer a variety of assistance, including first home buyer grants, stamp duty exemptions or reductions and share equity schemes. You can find out about these by visiting the relevant website – see a list here.
How can or should parents help?
As the adage goes, you can lead a horse to water, but you can’t make them drink. Therefore, it’s crucial that your child is motivated to purchase a property. Once their interest is confirmed, the next step is to teach them about borrowing responsibly. This entails instilling good cash flow management and savings habits to demonstrate their readiness for mortgage commitments.
One of the most effective ways parents can assist their children is by providing a family guarantee. This method helps first-time buyers overcome the significant financial hurdle of accumulating a sufficient and sizable deposit. Given that property prices often outpace the rate that first-time buyers can save, a family guarantee becomes invaluable. Additionally, it helps circumvent costly Lender’s Mortgage Insurance, as previously discussed.
Another common method of aiding children in entering the property market is by offering a cash gift to bolster their purchasing power. However, it’s essential to consider the ramifications if your child experiences a de facto or marital relationship breakdown. In such scenarios, their former partner may have a financial claim on the assets, including the gift provided by you.
Co-owning property with children can be complicated. All owners must be involved in any loan agreements, meaning parents will need to act as co-applicants or guarantors on their child’s loan. Moreover, transferring ownership solely into the child’s name in the future could trigger Capital Gains Tax (CGT) and stamp duty liabilities. This aspect requires careful consideration, so make sure you receive professional advice.
A recent experience that resulted in a great outcome
Our experienced mortgage team recently helped a first-time buyer, Michael. Michael was living at home with his parents and was very motivated to buy his first property. To maximise his borrowing capacity and purchasing power, we arranged an investment loan pre-approval for Michael. At that stage, it was Michael’s intention to continue living at home and rent out his new property.
Once Michael purchased his property, he decided to occupy it as his home. He changed his electoral role details, connected his utilities and so on to ensure he had evidence that his was living in the property. This was important so that he would be entitled to the main residence CGT exemption. After 6 months of occupying the property, we provided evidence that Michael was occupying the property to his bank and they converted the loan product from investment to owner-occupier, which reduced the interest rate.
A few months later, Michael decided to move back home and rent out his property.
The consequence of this series of events is that:
- Michael has a home loan which attracts a lower interest rate than an investment loan;
- Michael will enjoy the negative gearing tax benefits from renting out his property i.e., the loan interest expenses are tax deductible; and
- Because Michael initially occupied the property as his main residence, he can continue to claim the main residence CGT exemption for up to 6 years, meaning that he won’t pay any tax on the capital gain over that period.
What to do next…
The first step is to establish the first-time buyer’s borrowing capacity. Together with any deposit/savings, this will help them determine a purchase price budget for the property.
Once the budget has been established, you can then consider how that budget is best deployed i.e., where will you achieve the highest return over the next 5-10 years. I almost always recommend consulting a reputable buyers’ agent to obtain professional advice.
How can Michael enjoy negative gearing tax benefits when the loan was converted to a home loan?
Because the loan product type (i.e., whether it’s a home or investment loan), has not baring on its deductibility. The loan purpose is the key considering regarding tax deductibility. See here (refer point # 5).
I am about to be a guarantor for my son to purchase his first investment property and was told by my mortgage broker that the amount being guaranteed is to be principal and interest repayments. Would this be correct?
All family guarantee products that I’m aware of involve ‘security guarantees’ not ‘serviceability guarantees’. That means your are guaranteeing the loan principal, not the repayments. If the borrower (your son) defaults in the loan by ceasing making repayments, and the bank has to sell this property to recover the loan, and the net proceeds are insufficient to repay the loan in full, then you are liable for the shortfall. Family guarantee are usually capped i.e. a fixed amount. However, of course, you should seek independent legal advice to ensure you understand the arrangements.