Buying a home is one of the biggest financial (and emotional) decisions you’ll ever make, but are you really ready?

In this episode, Mark and Shani step away from the noise and unpack the real questions you need to ask before you buy.

From hidden costs and emergency funds to flexibility, future plans and the emotional weight of home ownership, this is an honest, balanced look at what it truly means to buy property in Australia.

You can find the full article here.

You can find all the costs Shani paid on her first home here.

You can find the insights from one of Australia’s top buyer’s agents on what to look for in an investment property here.

Mark has written on how to weigh up investing in your mortgage or investing here.

You can find the transcript for the episode below:

Shani Jayamanne: Invest Your Way is a different kind of book about money. We want it to be a trusted resource for investors who have graduated from Investing 101. For investors who know what a share is and an ETF is, but are struggling to put it all together to get onto the pathway to financial independence.

Mark LaMonica: Too much financial commentary focuses on investments rather than on the people investing. We believe investors are hungry for a new perspective. The investors we talk to tell us that they are tired of aspirational messages that lack the practical steps to put a plan into action. They don’t want bewildering and unrelatable jargon and complexity. They want the focus to be on the only thing that truly matters, creating a better life for themselves and their loved ones.

Jayamanne: Invest Your Way is a guide to successful investing with actionable insights and practical applications. You’re able to purchase the book through the links in the episode notes and at major bookstores or request a copy through your local library.

Welcome to another episode of Investing Compass.

Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances or needs.

Rough start there, sorry.

LaMonica: I didn’t get the disclaimer right.

Jayamanne: I know.

LaMonica: That’s a little bit of a problem.

Jayamanne: Let’s see how this goes. So, you recently came back from a trip, Mark.

LaMonica: That’s true.

Jayamanne: Another trip to New Zealand. What did you do?

LaMonica: Well, I went to watch the Wallabies play at Eden Park in Auckland.

Jayamanne: And I’m guessing they lost.

LaMonica: They did lose. I mean, they put up a little bit of a fight…

Jayamanne: What was the final score?

LaMonica: …which was nice. I don’t remember exactly, but yeah, they put up a little bit of a fight. So, I’ve now watched the Wallabies lose in four different countries.

Jayamanne: What are they?

LaMonica: I’ve seen them lose in France. I’ve seen them lose in Japan. Now, New Zealand. Of course, I’ve seen them lose in Australia.

Jayamanne: Maybe you should stop going to these games.

LaMonica: I know. Interestingly, I’ve been to a lot of matches. I’ve seen one win.

Jayamanne: Okay.

LaMonica: That was in Paris.

Jayamanne: How was that?

LaMonica: That was in Paris against Georgia.

Jayamanne: Oh, okay.

LaMonica: So, it wasn’t exactly impressive. I saw one…

Jayamanne: Sorry to any of our Georgian listeners.

LaMonica: They know they’re not that good at rugby. I wasn’t insulting the country. And then I saw a draw once against Argentina in Paramatta, a match that you were actually at.

Jayamanne: Yes.

LaMonica: You bought your dad tickets to that.

Jayamanne: I did. Yeah. This is how I feel about when I go to see Sri Lanka play cricket. I’ve never seen them win a game.

LaMonica: But it has happened because you keep telling me about the ’96 World Cup.

Jayamanne: Yeah. Well, yes.

LaMonica: So, at some point it happened.

Jayamanne: The one since then that I haven’t been at any of those games.

LaMonica: Yes. And obviously, your theory is that there’s too much curry served in the dressing room.

Jayamanne: I know there is. I know there is. So, yeah.

LaMonica: Okay. So, it’s not a theory.

Jayamanne: No, it’s not a theory.

LaMonica: There we go. Well, today we’re going to talk about housing.

Jayamanne: Which is always controversial.

LaMonica: Yes. Much like Sri Lankan cricket. But we’re going to try to take the controversy out of it today. So, this isn’t about whether you should or shouldn’t buy a house based on the market or whether you should invest in shares instead. It’s a reflection exercise.

Jayamanne: Yes. This episode definitely isn’t more commentary on how unaffordable housing is. We’re going to go through the questions you need to ask yourself when you’ve committed to the goal of purchasing a home.

LaMonica: And this is important because buying a house is one of the biggest, if not the biggest, financial decisions you’ll ever make. So, once you’ve made the commitment, saving for a down payment requires a significant sacrifice. So, your ability to get together a deposit is only one of the questions you need to ask yourself before you decide to buy a house.

Jayamanne: And most financial decisions are about trade-offs. Purchasing a home is no different. There is the opportunity cost of having a large asset with large repayments and ongoing costs. And this will impact the rest of your financial goals and your life.

LaMonica: We’re going to start with asking the right questions. And one is whether this is actually financially feasible for you. So, you need to properly understand what the current and future costs of a home are.

Jayamanne: And I’ve written out exactly what buying my first home actually cost me. And it’s not as easy as dividing a sale price by 20% to get the deposit amount. There are a multitude of extra and hidden costs, many of which were unexpected for me. It was my first time doing it, so I had no idea about a lot of them.

LaMonica: And the key to achieving goal is to properly cost it. If your goal isn’t properly costed, you may end up overextending yourself or having to delay purchase until you have built in that buffer.

Jayamanne: And our costs ended up being 35% above our deposit amount. So, it is a significant amount where if you’re already saving for a deposit, you’ll need to account for it to avoid disappointment.

LaMonica: And then of course, once you purchase the home, there are also future costs. So, if you buy shares, the cost is known. You do not need to pay out of pocket for maintenance, repairs, bad tenants, or council rates. For people who have not purchased property before, it is easy to fall in the trap of only considering your mortgage payments as future costs.

Jayamanne: And I know you can speak about this, Mark, because even though you don’t own a property here, you own properties back in the US. Do you want to talk a little bit about your maintenance costs?

LaMonica: Yeah, I mean, I think the biggest thing is that you always hear these estimates, whatever that estimate is, 1% of the purchase price, or potentially higher, you hear estimates that are higher. But I think the thing is that they’re really lumpy. And so, I think that’s the thing that I’ve experienced that it is – yeah, something happens and it costs a lot. And then maybe something doesn’t happen for a couple more years, but I think just sort of the lumpiness of this stuff, and especially like if you own a of couple different properties, that the lumpiness can all come together. And I know that you are obviously a big fan of an emergency fund, but I think it’s making sure that, yeah, you have that buffer in your emergency fund or somewhere so you can deal with those maintenance costs. And then I think there’s also like the day-to-day stuff. So, whether that’s particularly for properties, investment properties, paying landscaping, paying things like that. So, considering those two different angles.

Jayamanne: There you go. You had a particularly bad tenant in one of yours.

LaMonica: I did. I did.

Jayamanne: You had the sheriff come and kick him out.

LaMonica: Well, yes, because they were evicted and then didn’t leave. So that was a little bit frustrating. But I think that was just – there was just a lot of bad luck. Like I had a tree fall in one of the places.

Jayamanne: You had like an iron mark on brand new carpet.

LaMonica: Yes, that was the person that refused to leave.

Jayamanne: Oh, okay.

LaMonica: Which I thought was interesting, at least they were keeping up with their ironing.

Jayamanne: Yeah.

LaMonica: So, I don’t iron any of my clothes as people can probably tell if they’re watching the YouTube videos, but at least this person was.

Jayamanne: All right. So, outside of Mark’s bad luck the general rule is maintenance costs are 1% of the purchase price per year. The Homeowners Association of Australia believe this cost is closer to 3% for new homes and 5% for older homes. And what is important is that you don’t get financial stress trying to meet your mortgage obligations and keeping your home in a livable condition.

LaMonica: Yeah, and that’s a huge, like 3% to 5%...

Jayamanne: I know.

LaMonica: …especially when you consider you always hear like what the median house is a million dollars now, so up to $50,000 a year.

Jayamanne: Yes.

LaMonica: That is a lot of money. So, one of the things to consider are some of the other costs that you don’t think about. So, maintenance, I feel like people at least sort of intuitively know that, but Shani, you said that somehow your deposit is 35% higher. What are some of these additional costs that you found?

Jayamanne: All right. So, this is a bit of a laundry list, but mandatory home insurance is part of your mortgage, contents insurance, maintenance and repairs, recurring mortgage maintenance costs, any increases in interest rates, council rates or strata fees and land tax if it’s applicable in your state.

LaMonica: And I think this gets back to what Shani was saying or what I was saying earlier, but Shani’s love of an emergency fund and making sure that that is also properly funded. So, that might involve saving more in addition to your deposit and all these costs just so you do have that buffer and the kind of rule of thumb there three to six months if you’re employed by somebody else, but then potentially a year if you’re self-employed.

Jayamanne: And I know that saving a deposit is a mammoth task, but saving for an emergency fund as well as that may seem insurmountable. But just remember an emergency fund is also important to reduce stress, which is an under-appreciated benefit. And for many, and I know this was the case when we bought a home, the point of purchasing a house is to give you emotional and mental security. And it’s hard to do that if you’re stressing about how to pay the mortgage and any home repairs that you may face.

LaMonica: Do you feel like you have emotional and mental stability as a homeowner?

Jayamanne: No, I don’t think I’ve ever had that, but…

LaMonica: Is it better?

Jayamanne: I don’t know. Probably not.

LaMonica: Okay. Well, there you go.

Jayamanne: I don’t think it’s related to the home, but…

LaMonica: Yeah. There’s an endorsement to buy a home. But I think that this sort of leads into the next section is a question about actually reflecting on what are the real reasons and if they’re the right reasons that you’re buying a home. So, our behavioral research team at Morningstar has done a lot of research into setting better financial goals. And the research shows that people will often succumb to preconceptions about what they think they should want. And this isn’t just an academic concept. We are constantly under societal pressure about where we should and shouldn’t spend our money and what success looks like. So, this translates into what we think we should own. There is a lot of societal pressure, especially in Australia, to own your own home. And you need to balance this, of course, against the huge financial commitment that a home is.

Jayamanne: That’s right, Mark. And this isn’t meant to be a lecture, but you do need to go into it with both eyes open. You will have severely garnished cash flows for decades through your mortgage payments. The amount you’re contributing to your mortgage means that it’s not being contributed to other goals and it’s missing out on being invested and the compounding that comes with it. And your life will be less flexible and you may not be able to move at a moment’s notice for a career opportunity, for a gap year, or you might think twice about leaving a relationship. And if you have unexpected costs, you can’t just sell the kitchen. The whole thing needs to be disposed of. So, it adds a level of complexity to your decisions.

LaMonica: So now that we’ve lost all of our real estate agent listeners, we can just move on. So, I think one thing the financial services industry does have a tendency to reduce the home down to just seeing it as an asset, an overpriced asset with a lot of costs that reduce cash flow. But I think the question then, Shani, and I’ll ask this to you, as someone who owns a home, unlike me, why is everybody still so into owning a home?

Jayamanne: Yeah, I mean, a house can obviously be an asset, but it can also be a home and it’s permanency. It’s the ability to build a home for you and your loved ones with security. And a home is a trade-off. Life isn’t just about what following the most efficient way to create wealth is and following that path, but it’s about living the life that you want to live.

LaMonica: Yeah. And I think that that distinction between an asset and a home is something that you should contemplate if you’re considering buying a home. So, neither option is bad, but they require very different approaches. So, what if you’re just interested in property as an asset?

Jayamanne: Yeah. So, if you’re interested in property as an asset, it is about considering it against other available investment options and understanding whether it’s the best option. And it’s a much more logical lens and you want to try and remove the emotion from the purchase. And Mark has written an article. It’s linked in my original piece that’s in the episode notes. His article considers whether a mortgage or investing may be the best place to place your money. And do you want to talk a little bit about the article, Mark?

LaMonica: I do. I think what I tried to do in the article was there is this, whatever you want to call it, a rule of thumb saying that the interest rate that you pay on your mortgage is essentially the hurdle rate. So, the amount that you have to exceed with some other investment to make it worth it investing in that investment and not paying off your mortgage. And that’s actually not true at all. Like if you do the maths behind that, a huge – there are other considerations, but a huge consideration is tax. So, depending upon if you are in a primary residence where if you sell that, there is no tax versus an investment property where there is tax when you sell it, but there’s other tax benefits through negative gearing. And then of course, what your situation is from a tax perspective on the other side. So what tax bracket are you in? Are you investing in super where there’s lower taxes? So, I think more than anything, I tried to spell all of that out so that people really understood all the different drivers for whether they should invest or not invest. And you can calculate that number and there is a spreadsheet that I’ve created to calculate that number. But of course, the unknown is you don’t know what return you’re going to get from the investment. So, you have to sit there and say, okay, my hurdle rate is 5%, am I actually going to get that? Because you have no idea. Obviously markets can go in any direction.

Jayamanne: Or the price you’re going to sell your house for.

LaMonica: Exactly. Exactly. Which is also really difficult to come up with.

Jayamanne: Yes. And so, if you’ve decided on a house as an asset, I have interviewed one of Australia’s best buys agents to help you wade through the real estate noise. But okay, let’s move on to viewing your property or home as a financial goal instead of an asset. So, if you’re interested in property as a home, consider it like any other financial goal. This involves considering the opportunity cost. So, in many cases, it is renting and having more cash flow for other financial goals.

LaMonica: And prioritizing goals is central to – you referenced that earlier – the research done from our behavioral research team. So, part of understanding whether home is right for you is asking yourself what you’re actually trying to achieve by buying a home. So, the home may only be what we call a surface-level goal. In reality, you might be craving security. You might be thinking you want a house, but really are interested in building wealth.

Jayamanne: And if security is what you crave, there may be other ways to gain it. So, could you create the same sense of security through investing and creating wealth so you’re able to live where you want to and handle any rental increases? Is it as simple as a really large emergency fund? If it’s about a financial investment, would other assets work better for you? So, thinking about the deeper level goal you’re trying to accomplish may help with a more objective evaluation of the advantages and disadvantages of a property.

LaMonica: And one other – and Shani talked about this earlier – but one other point, like if you are trying to crave security and you end up overextending yourself, well…

Jayamanne: Are you actually achieving it?

LaMonica: Yeah. No, you own a home, great, but you can’t pay your bills. You worry about money all the time. You’re not actually getting any sort of security. So yeah, something to think about.

But I think if you’re going through this process, a good place to go through – go through this process of properly defining your goals, and that hopefully makes your goals a little clearer and the motivations behind those goals before you make the biggest purchase of your life potentially. So, it’s this method, once again, that’s been developed by our behavioral research team. It’s used by financial advisors to try to help their clients make better decisions and prioritize goals better. So, Shani’s article has a link to all of those steps.

Jayamanne: And another big question is what your future plans are. And this is important because buying a home can add complexity and inflexibility when you’re making future plans. So, before you commit to a home, understand what you want your future to look like and what truly makes you happy. And that you might find that the inflexibility is quite challenging of owning a home.

LaMonica: And it is worth noting here that you don’t need to know your plans in certain terms, because not many of us, of course, do, but it’s still worth considering how impractical potential situations may become with the mortgage.

So, we have a couple of questions you can ask yourself. Do you see yourself living in this area for the long term? Are you purchasing in any intercity suburb with no nearby schools and you plan to have a family? What is right for you now may not be right for you in the future. So, consider the frictional cost of having to sell and then repurchase a home if your priorities change or even if you’re just following some pathway you already know you want to do.

Jayamanne: And do you want to live overseas? And if so, does renting make more sense until you know where you are planting your roots? And this is particularly important if you’re considering purchasing and then transitioning your home to an investment property. Many of the tax advantages that you do get with investment properties are only advantageous if you have an Aussie income.

LaMonica: And of course, your plans in the future, is this just a home that you’re trying to use to get onto the property ladder? And if it is, consider once again those frictional costs that are involved with buying makes sense. It’s also important to understand that the home that you consider best for you may not make sense as an investment property. So, what’s attractive in a rental isn’t always attractive in a home and vice versa.

Jayamanne: Buying a house involves more than securing a 20% deposit and making a successful bid at an auction. It is a huge and ongoing financial commitment that you need to consider through a broad lens. How does it interact with what you want from life and your other financial goals?

LaMonica: And do yourself a favor by honestly reflecting on these questions. If anything, it’s an exercise that will strengthen your resolve in purchasing a home or a property, which is important because you’re going to have to sacrifice a lot for it.

Making a research and intentional choice will give you confidence in your decision and ensure you know what you’re getting yourself into. So, thank you guys very much for listening. We really appreciate it and we will be back next week with a new episode.

Invest Your Way

A message from Mark and Shani

For the past five years, we’ve released a weekly podcast and written on morningstar.com.au to arm you with the tools to invest successfully. We’ve always strived to provide independent, thoughtful analysis, backed by the work of hundreds of researchers and professionals at Morningstar.

We’ve shared our journeys with you, and you’ve shared back. We’ve listened to what you’re after and created a companion for your investing journey – Invest Your Way. Invest Your Way is a book that focuses on the investor, instead of the investments. It is a guide to successful investing, with actionable insights and practical applications.

If anyone would like to support this project you can buy the book now. Thanks in advance!

Purchase from Amazon

Purchase from Booktopia