Turning your home into an investment may not be worth it
Being a strategy focused fee-for-service planner, I have many clients whom are in their thirties. Many of these clients made their first step into the property market by buying a unit. It’s not just a unit, this unit is their home. As time moves on – a couple becomes three, then four as the patter of little children’s feet start running around the unit kitchen floor. The time comes that they want to move to a larger home. With higher incomes this is now a possibility to move to a larger home. Many clients say to me that they want to keep their unit that was previously their home as an investment property. I’m going to share with you why this is not a smart financial move.
Let’s say they bought this unit ten years ago for $500,000 with a 10% deposit and benefited from the first home owners’ grant at the time which covered most of the stamp duty. After ten years the unit is now worth $850,000 and the outstanding home loan is $367,000. The bank is able to lend around $313,000 using this unit as a security towards the purchase of a new home valued at $1.5 million. Many people would draw the equity from their existing home and use it as a deposit towards the purchase of a new home, thus keeping the old unit that was their home and leasing it out as an investment property. The additional loan on the new home including purchase costs would be around $1.269 million. However, being a home, all the debt drawn from the equity in the unit and the new home loan is non-deductible debt. The weekly loan repayments on the new home are a whopping $2,211 a week at 5% interest on a principle and interest home loan. Keeping the old unit now as an investment property has a weekly holding cost of $82 per week, after tax deductions. So the total exercise of keeping the old unit that was their home as an investment property and buying the new home has a weekly outgoing cash flow of $2,293 per week. OUCH!
So what happens if they were to sell their unit? The net proceeds after the sale of the unit would be around $457,500 (This is after paying commissions to the real estate agent for selling the unit and paying off the original home loan). All of the cash proceeds from the sale of their old home can be used as a deposit towards the new home. This amounts to almost a 30% deposit. Remember too, selling the old unit is capital gains tax free as it has always been their primary place of residence. The new home loan repayments on the $1.5 million home are $1,589 per week. A saving of $622 per week.
The most impressive part is that by selling their old home and using the cash as a deposit for their new home, the savings they will make in their home loan repayments on their new larger home over the life of the loan saves a whopping $890,000 in non-deductible home loan repayments!
Secondly, as the loan-to-value ratio (i.e. the amount of debt against the value of the home) is under 80%, the bank may be able to lend them more money to continue a separate investment strategy.
It makes sense to look at all scenarios when you are thinking of moving home. Most financial planners will not even consider talking these types of strategies with their clients as they are usually focused on managing share portfolios and managing what cash you have available to invest. It is very satisfying to help clients with proper financial strategies that save them hundreds of thousands of dollars.
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