Have you ever wondered how young people who have just finished university could possibly afford to own property? It seems out of reach to most graduates, but it doesn’t have to be. In this first instalment of the Rich Grad, Poor Grad series, Andrew Courtney a UQ Master of Commerce graduate will explain that it comes down to breaking the status quo.
The age-old saying that knowledge is power has never been more true. Couple that with the ability to implement that knowledge, and young people fresh out of university can build a solid financial foundation faster than they think.
The biggest issue young people face when planning their financial future is being caught up in the whirlwind of following the status quo – following peers into what they ‘should’ do with their money, which is usually live big and spend big. Of course, young people also often listen to their parents on these important matters – and most of the time they will say “save, save, save so you can enter the property market”.
An optimised financial strategy doesn’t produce significant results a year or two out of university, but when you start talking five or ten years, massive shifts start to happen as the power of compounding starts to kick in. Financial planning requires strategic, long-term thinking.
The problem is, with information galore available online, from parents, peers, colleagues and even from the local taxi driver, it’s easy to become overwhelmed and end up with ‘paralysis through analysis’.
When people become overwhelmed, the standard response is to revert to the status quo. Most young people will either live from pay cheque to pay cheque, or save feverishly for a 20–30 per cent deposit for a home worth around $450,000.
For these people who are happy to save their pennies, after saving a huge deposit, most will buy a property and try to pay off the mortgage as quickly as possible; renovations might be on the agenda, then most will sell and upgrade their home. This usually happens on a seven-year cycle continuously until retirement. Sound exhausting? That’s because it is.
If you planned to save a deposit of 20–30 per cent on a $450,000 property you would need a minimum of $90,000. That property would typically grow in value by 5–10 per cent per annum, meaning each year you held off, that property will most likely grow in value by at least $20,000 which adds an extra $4,000–$6,000 of extra savings needed for the deposit…per year!
You can see where I’m going with this. You will never get there if you use the strategies our parents used to enter the property market, and if you do get there, the amount of money lost (or opportunity cost) by going with this option is ludicrously high.
So how do you break the status quo?
Instead of saving $90,000 for a 20 per cent deposit on a $450,000 property, why not save just $22,500 or 5 per cent instead?
If you are buying a Principal Place of Residence (PPR) – a home that you will live in – most banks will happily lend you 95 per cent of the value of the house. This is the easiest way to get into the property market without getting help from anyone (except the banks, of course).
These two scenarios can be separated into Rich Grad and Poor Grad:
At the end of five years, Poor Grad will have saved about 20–30 per cent of a $450,000 buy price and is now ready to buy. Rich Grad on the other hand, acquired a $450,000 property four or five years ago and that property has grown in value by approximately 5 per cent per annum and is now worth over $570,000!
Now before you go out and acquire that first property of yours, you must understand the risks associated with doing so. Investing in property is a long term game. To safely bank on growth, properties that are worth acquiring tick four major boxes:
The large costs associated with buying and selling property will considerably hamper your wealth curve therefore, buy only for the long term (unless you have another strategy in mind). Borrowing 95 per cent of your home value will undoubtedly help you acquire a property faster but you must remember that your loan will also be larger which means higher interest repayments. Any loan above 80 per cent Loan to Value Ratio (LVR) will also incur Lender’s Mortgage Insurance (LMI) which can range from 1 – 3 per cent of the value of your home which can be added to your loan.
Rich Grad who opted to buy earlier had enough capital growth in the property to absorb the initial costs associated with the purchase like LMI and the extra repayments associated with the loan (after 5 years of 5 per cent growth). Rich Grad managed to get on the property ladder earlier than Poor Grad, who now will need to look for a suburb that is further out as the initial $90,000 they saved no longer is large enough to purchase in the original suburb. This is the main reason why first home owners tend to be forced to buy in the outskirts of the city as they tend to get priced out of the market.
The moral of the story is, there is always a way to acquire a property earlier but there is always a price to pay to do so. Ensuring that you’re on a winner is the first step to making a confident decision to acquire and also knowing the rules of the game to mitigate the surprises you may encounter along the way. Acquiring property is not unlike a rollercoaster ride of emotions. Knowledge and confidence are the two factors that will keep the turbulence of your journey to a minimum.
Thinking and planning long term is key to achieving financial success, and in becoming the Rich Grad.
Find the original blog post here.