It’s spring time, so the barbecues of Canberra are coming out of hibernation, and there’s sure to be a conversation or two about somebody’s new home.
There aren’t many people that don’t love to live in and look at a nice home, but is it a smart financial choice?
The answer of course is… it depends. There are a lot of personal factors that go into whether buying your own home is a smart financial choice, but here are some of the reasons that it can be a smart financial choice:
1. Home owners are financially well behaved
Owning a home is no guarantee of good financial behaviour, but most people who take out a home loan to buy a home will do so with a principal & interest loan spread over 25 – 30 years. This means that ever so gradually they are paying down their loan and building equity in the property so that they own more, and the bank owns less.
Housing loans are also relatively simple financial products, and people understand that making extra repayments will dramatically reduce the interest paid over the life of the loan, so they will often do this with increased pay, or unexpected lump sums such as an inheritance.
2. Owning your place removes the risk of rent increases
A common concept in finance is that of ‘hedging.’ It means limiting or offsetting the loss from the movement in the price of a commodity.
One commodity that we all need for the vast majority of our lives, is accommodation. If we are renting, and paying the cost of rent from either our salary, or a portfolio of other investments such as cash and shares. When doing this we are always carrying the risk that rent might increase at a rate that is greater than our salary or income from investments, so we have to reduce other expenses or saving to fund the gap.
When you own the home that you’re living in, you’ve removed this risk from your finances.
3. It’s simple
There are strategies out there for how those who don’t own their own homes should invest, but they do involve greater complication.
Your own home is exempt from capital gains tax, so you don’t have to worry about that. This also means that you have less record-keeping obligations than you do when you have investments that generate income and tax deductions.
If you get to retirement with your own home paid off and a reasonable sum in super to provide your income, you’ve already won half the battle.
4. Banks love lending against property
I won’t get into the specifics of how banking regulation causes this, but banks will lend money to you at much lower rates when you can offer a residential property as security.
If you need to borrow for things like starting a business, or other investments, a line of credit or other drawings against a residential property will set you back far less in interest than alternatives. You alternatives might be things like:
- Business loan (1.50 – 2.00% pa higher interest)
- Margin loan (2.00 – 3.00% pa higher interest)
- Personal loan (3.00%+ pa higher interest)
- Credit card (don’t ask how much higher interest!)
5. Home owners get a better deal from social security benefits
Owning your own home is still treated quite favourably when it comes to social security benefits such as the age pension, or costs of aged care services.
The difference between the ‘homeowner’ and ‘non-homeowner’ asset tests for the age pension is $146,500. This means that a non-homeowner can have an additional $146,500 of assets than a homeowner, before their age pension payments begin to reduce. Unfortunately, in most major metro markets of Australia, it’s unlikely that $146,500 of financial investments will come anywhere near covering the costs of housing.
When working out the cost of your aged care, the home is included but only up to a cap which is currently $154,179. Given the price of property in many Australian markets it’s likely that this cap will be well under the value of the home. If you choose to rent out your home when moving into aged care, the income will also be exempt from age pension calculations.
There are also reasons that owning a home may not be a smart choice at a particular point in time, but there are certainly at least a few factors in favour of ownership that should be considered in any sensible financial plan.
PS – I’ve now also written on a few reasons you might not want to buy your home right now.