Your new home – buy or rent?

Buying your first home is an exciting time, but often young people leap into it without weighing up all their options first. Buying a property at a young age is great, and can potentially set you up for life. However, it’s also important that this is done in a way that doesn’t compromise your lifestyle.

This article will hopefully make you think about the various choices you have when entering the property market. There is no right or wrong here, it’s simply about making an informed decision that’s right for you.

Firstly, let me say there is no clear answer as to whether buying or renting is better. This is a topic where you will get many varying opinions and I am not trying to influence you either way. I just want you to be informed to make the best choice for your circumstances.

To me, the first thing you need to know is where you want to live. We often make compromises on this point as we get older. As time goes on you may need to move your home for many reasons – for work, to afford a bigger place to bring up your kids, or to be closer to elderly family members.

My opinion (and remember this is all about opinions) is that when you are young you should live where you want to live. When you know where that is, ask yourself the question ‘Can I afford to buy there?’ If the answer is no, then you have two options:

• Buy somewhere else so you can follow the Australian dream of home ownership, or
• Rent where you want to live.

There has been a lot written about home affordability and how hard it is for young people to buy their first home these days. This argument does have some merit, but at the same time many first home owners can afford to buy their first home. There’s only one issue: it is not in the place they want to live.

The main argument against renting instead of buying is the multiple variations of the old saying that “Rent Money is Dead Money”. I simply don’t agree.

How can it be dead money if it is providing a first home for you outside your parents’ home? Further, how can it be dead money if it’s potentially giving you (and maybe your partner) a place to start your life together and perhaps raise your children? Further, if renting puts you closer to work, family and your preferred social locations, then there is a financial and time advantage in there for you as well.

So, with this in mind, there is a choice to make:

Is buying your own home worth living somewhere you don’t want to live?

A look at the numbers

Graeme and Jenny have saved a deposit, and have approval to buy a new home for $320,000 in outer metropolitan Melbourne (no affordability crisis there). However, they want to live in Prahran (2kms from the CBD) as they both work in the city and simply love the location. They can’t afford to buy in Prahran, so they need to decide if they want to rent in Prahran, or compromise on location to buy their own home?

How would this play out financially?

If they buy a home in the outer suburbs, borrowing at 90% LVR, their mortgage would be $288,000. At 6% on principal and interest loan the repayments will be $398 a week. They also need $80 a week for rates, insurance and maintenance, which comes to total $478 in total.

As well as this, they have to commute to and from work for two hours each day. They can use public transport for this, costing $110 a week for both. Giving them a total of $588 a week for their home and travel costs.

Let’s now compare that with renting in Prahran. They have done their research and know they can rent a modern one bedroom, one car park apartment in Prahran for $350 a week. They will save $238 a week, or $12,376 a year, compared to buying their own home.

But what about the lost capital growth? Consider the following scenario, where they buy the same property in outer metropolitan Melbourne as an investment.

The $320,000 investment property would be negatively geared by $50 a week (based on an $80,000 taxable income). What this means is, after tax breaks on the property, Graeme and Jenny will have to put $50 toward the property each week.

Paying rent and contributing $50 a week towards their investment property would mean their weekly payment is $400, instead of $588. This scenario will still leave them nearly $10,000 ahead per year, living the life they want and still property owners.

What about Capital Gains Tax when they sell?

Well, yes, they do have to pay capital gains tax when they sell, but they only pay it on 50% of the gain, plus other factors are taken into account which will further reduce the amount.

And don’t forget they are $188 a week ahead in this example. If they take just $100 of this surplus cash and use it to pay down debt on their investment property, then in 12 years they can expect the following result:

Property value: $640,000 (based on 6% growth p.a.)
Debt: $136,000
Equity: $504,000

If they sold the property, including sale costs of $18,000 and a capital gains tax of about $86,000 they would have an overall gain of $400,000. Perhaps a deposit on a home of their own in their ideal location!

In this scenario they get to live in their dream suburb and still become property owners. From their investment they will make, on average $33,000 a year profit (after tax). As well, they will still have $4,500 to live the life they want while they are young. In my opinion, this is definitely a worthwhile strategy for young people to keep in mind when thinking about entering the property market.

For more information about Michael Sloan go to: The Successful Investor

For property calculators and resources developed by Michael Sloan go to: Property Investor Toolkit