Future Focus: Are you making the right decision saving for a home?
How to weigh up whether the biggest financial commitment you will likely make is right for you.
Buying a house is one of the biggest financial decisions you’ll ever make. Once you’ve made the commitment saving for a down payment requires significant sacrifice. 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.
This article isn’t more commentary on how unaffordable housing is. This article is about the questions you need to ask yourself when you’ve committed to the goal of purchasing a home.
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. This will impact the rest of your financial goals and your life.
Start with asking the right questions. Here’s a list to help you.
What are the current and future costs?
I’ve written on what buying my first home actually cost me. 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.
The key to achieving a goal is to properly cost it. Our costs ended up being 35% above our deposit amount. If you do not account for these costs, you may end up overextending yourself or having to delay purchasing until you have built in a buffer.
Future costs
When 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 into the trap of only considering your mortgage payments as future costs.
A general rule is maintenance costs are 1% of the purchase price per year. The Home Owners Association (Australia) believe this cost is closer to 3% for new homes, and 5% for older homes. What is important is that you do not get into financial stress trying to meet your mortgage obligations and keeping your home in a livable condition.
Consider some of the following costs that may not have been factored into your budget:
- Mandatory home insurance as part of your mortgage
- Contents insurance
- Maintenance and repairs
- Recurring mortgage maintenance costs
- Any increases in interest rates
- Council rates or strata fees
- Land tax (if applicable)
A good rule is to ensure that you have a properly funded emergency fund before you think of committing to a house. 3-6 months of living expenses is a good buffer for salaried individuals, 1 year is recommended for self-employed.
I know that saving a deposit is a mammoth task. Saving for an emergency fund too may seem insurmountable. Just remember an emergency fund is also important to reduce stress which is an underappreciated benefit. For many, the point of purchasing a house is to give you emotional and mental security. It is hard to do that if you’re stressing about how to pay the mortgage and any home repairs you may face.
Are you buying for the right reasons?
Morningstar’s behavioural research team has conducted comprehensive research into setting better financial goals. Their research shows that people often succumb to preconceptions about what they think they should want.
This isn’t just an academic concept. We are constantly under societal pressures about where we should and shouldn’t spend our money and what success looks like. This translates into what we think we should own.
There is societal pressure to own your own home but you must remember a house is a huge financial commitment.
You will have severely garnished cashflow for decades through your mortgage payments. The amount you are contributing to your mortgage means that it’s not being contributed to other goals. It’s missing out on being invested and the compounding that comes with it.
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. If you have unexpected costs, you can’t just sell the kitchen. The whole asset needs to be disposed of. It adds a level of complexity to your decisions.
The perspective that financial commentators bring is to view a house just as an asset. An overpriced asset with many costs that reduces our cashflow. So why is everyone still clobbering to own one?
A house can be an asset, but it can also be a home. It is permanency. It is the ability to build a home for you and your loved ones with security. A home is a trade-off. Life isn’t just about what following the most efficient way to create as much wealth as possible. It is about living the life that you want.
The way that you approach your purchase should involve contemplating whether you are considering a house as an asset or a home. Neither option is bad - but they require very different approaches.
Property as an asset
If you’re interested in property as an asset, it is about considering it against other available investment options and understanding whether it is the best option.
My colleague Mark LaMonica has written an article that considers whether a mortgage or investing may be the best place to put your money. If you’ve decided on a house as an asset, I have interviewed one of Australia’s best buyers agents to help you wade through the real estate noise.
Property (a home) as a financial goal
If you’re interested in property as a home consider it like any other financial goal. This involves considering the opportunity cost. In many cases, it is renting and having more cashflow for other financial goals.
The process of prioritising goals is central to the Morningstar research I referenced earlier. Part of understanding whether a home is right for you is asking yourself what you’re actually trying to achieve by buying a house. The home may only be 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.
If security is what you crave there may be other ways to gain it. Could you create the same sense of security through investing and creating wealth so you’re able to live where you want and handle any rental increases? Is it as simple as a large emergency fund?
If it’s about a financial investment, would other assets work better for you? Thinking about the deeper level goal you are trying to accomplish may help with a more objective evaluation of the advantages and disadvantages of property.
I recommend going through the process of properly defining your financial goals to get clearer on what you want before making the biggest purchase of your life. You’re able to find the steps to do this in this article.
What are your future plans?
Buying a home can add complexity and inflexibility to future plans. Before committing to a home, understand what you want your future to look like and what truly makes you happy. You may find inflexibility challenging. You don’t need to know your plans in certain terms – not many of us do – but it is worth considering how impractical potential situations may become with a mortgage.
A few questions to ask yourself:
- Do you see yourself living in this area for the long term? Are you purchasing in an inner-city suburb with no nearby schools and plan to have a family? What is right for you now may not be right in the future. Consider the frictional costs of having to sell and repurchase a home in your decision.
- Do you want to live overseas? If so, does renting make more sense until you know where you are planting roots? This is particularly important if you considering purchasing and then transitioning your home to an investment property. Many of the tax advantages that you get with investment properties only are advantageous if you have Australian income.
- What are your plans for the future? Is this a home that you’re using as a way to get onto the property ladder? If so, consider if the frictional costs that are involved with buying make sense. It’s also important to understand that the home that you consider best for you may not make the most sense as investment property. You can find what is attractive in a rental property here.
Final thoughts
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?
The questions to ask yourself are simple but the answers aren’t always easy:
- Can you afford not just the current costs, but the future ones?
- Are you buying for your needs or because you feel pressure to?
- Is it an asset or a home? If it is an asset, are you buying the right one for your financial goals?
- Do your goals align with homeownership or are there other ways to achieve them?
- How do your future plans fit with the reality of a mortgage and owning your own home?
You will do yourself a favour by honestly reflecting on these questions. If anything, it is an exercise that will strengthen your resolve in purchasing a home or a property. Making a researched and intentional choice will give you confidence in your decision and ensure that you know what you’re getting yourself into.
Invest Your Way
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