This month, we are featuring Peter Bohem's informative article - How first Home buyers Can Get into the Property Market. Please feel free to share this article, originally published on the Onthehouse Investor Centre, with your buyers and landlords.
How to use an investment property as a stepping stone into your first home.
Buying your first home has vast similarities to climbing a mountain – not only is it hard work, you often hit what is known as a false peak.
In mountaineering, a false peak is where a climber ascends to what looks to be the top of the mountain, only to discover it is nothing more than a ridge that has obstructed the real peak behind it. This can be disheartening because of all the hard work that has gone into the trek thus far, not to mention the discovery that there is still some way to go before the true summit is reached.
The term false peak can also be applied to non-mountaineering activities where obstacles posing as the end goal produce similar feelings of dashed hoped (or even failure) – such as the process of buying your first home.
Buying Your First Home
When buying your first home, you go through the hard work of saving a deposit – which often takes years – but the deposit itself is not the final destination in your home ownership quest, it is only the ‘ridge’. The true destination will only be reached when the final mortgage payment is made and you own your home outright. In the meantime, you have to make regular mortgage payments, on time every time, otherwise you will struggle to make it to the top.
Bridging the Gap
Bridging the deposit gap and ongoing mortgage affordability are two big obstacles first time buyers face, and for many it has become a mountain too big to climb.
So, how can you move into your first home if you don’t have a deposit big enough or you can’t afford mortgage repayments? One way, as strange as it may seem, is to buy an investment property and use it as a stepping stone into your first home.
With this in mind, here are 3 ways to you can use an investment property to help you into your first home sooner.
1. Create Rental Income
You may have found a property you would like to call home but you can’t quite afford to buy it as an owner-occupier just now. The solution – if the property is well-located and is in an area with good rental demand, buy the property as an investment and lease it out. This way, you can get a tenant who will help pay off your mortgage until your finances improve. Once you are on top of your finances and can afford to take on the whole mortgage, you can move in.
You would have to buy and borrow wisely but this approach would help your cash flow and could accelerate your loan repayment if you combine with your tenant and contribute more than the minimum mortgage payments.
2. High Growth for Capital Gain
More often than not, your first home is not going to be your dream home. To get a foothold on the property ladder, you may need to go down the investment property path first and buy a property you can afford NOW. This does not have to be in an area you ultimately want to live – in fact many people have investment properties in areas outside of where their primary point of residence is.
Buying an investment in a suburb that offers high capital growth potential allows you to sell the property after a few years of solid growth, and you can then use the after tax proceeds to help fund your new home.
If you choose to adopt this strategy, you should aim to find areas that offer potential returns in excess of other asset classes, like online savings accounts. At the very least, aim for capital growth rates of inflation plus at least 2%.
>This can be an effective way to bridge the deposit gap, and if the property performs really well, it could help reduce the amount you ultimately need to borrow to buy your new home. This thereby improves affordability and savings on interest, and will perhaps even save you needing Lenders Mortgage Insurance if you can get the loan-to-value ratio under 80%.
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3. Build Up Equity
Similar to my above strategy, buy an investment in a suburb that offers high capital growth. However, instead of selling the property for a capital gain, you can borrow against the equity you have created to help fund your first home.
If you choose to go down this road, you need to be mindful that this option requires you to manage the debts associated with two mortgages, so it is very important that you do your sums and don’t overstretch your financial capabilities.
In closing, here are some important issues to consider if you plan to explore any of the above options further:
- Prepare a Budget
Make sure you prepare a budget and get independent tax and accounting advice. You need to ensure the approach you want to take stacks up financially (cash flow and tax) and that it is likely to meet your home ownership objectives in a timeframe you are comfortable with.
- Risks vs. Rewards
Make sure you understand the risks as well as the rewards of property investing. For instance, you need to be ready to take on the financial and personal responsibility of being a landlord. You also need to remember that investing in property is investing in an illiquid asset – so you may not be able to liquidate your investment as quickly as you would wish.
- Know the Market
Property prices can go down as well as up, so there may be some risk to your capital. Also, you’ll need to set a minimum three to five year time horizon to recoup acquisition costs and generate a decent capital growth.
- First Home Buyer Grants
Check with your State or Territory whether there is any effect on your eligibility for first time buyer grants and concessions if you buy an investment property first. The criteria for these change regularly so make sure you’re across any developments.
- Track the Market
Keep a close eye on how your investment property is tracking in terms of cash flow and capital growth. Any material divergence needs to be investigated and actions taken without delay.
About the Author:
Peter Boehm is the Finance Editor for Onthehouse.com.au.