Should I buy a [PPR] house to live in or invest in?
01 Dec 18
One of the big questions that Defence Force home buyers ask is whether they should invest in a property before buying a home to live in.
This is a valid question. The two scenarios of borrowing to buy a house to live in and investing in a property are miles apart.
Here is why first home buyers should consider investing in property as an option worth weighing up. Let me show you some numbers, and you can decide for yourself.
On the go? Here’s 30 seconds of take outs:
- As a Defence force member there are some great home buyer incentives in place. At the same time, the rent allowance incentive now may be a better choice to support your lifestyle goals in the future.
- I’m not going to tell you whether to buy your first home to live in or invest instead. I do want you to have the knowledge to understand the numbers. The numbers tell the story.
- Don’t make decisions based on dangled carrots. Work out how many carrots you can pop into storage in the medium and long term before you jump at an incentive to buy property.
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In a wealthy country like Australia, home ownership is a popular aspiration. At the same time, we know that property investment can turn a disposable income into a secure financial future.
If you’re earning a secure income for the longer term you could own your own home or start investing in property. With your future lifestyle goals set, and a healthy savings plan in place this choice can pose a real dilemma.
The two questions you need to consider are:
- How much money do you need to buy the property?
- What are the ongoing costs of holding the property over the long term?
Knowledge is power when it comes to making smart decisions. Let’s explore both the options in front of you, further.
The holding costs of being a first home owner
In investment and financial speak, your Principal Place of Residence (PPR) is the property that you live in. Your PPR commits you to principal and interest repayments on your loan, and all the outgoing costs such as maintenance and renovation costs, insurances, rates and all the other day to day expenses associated with owning property. And funding all these outgoings? After tax. Youch.
The holding costs of living in the residential property you’ve borrowed money for, are much higher than if you buy a residential property as an investment.
The holding costs of investing in a residential property
A residential property that you have purchased as an investment commits you to interest only repayments on your loan, and all the outgoing costs such as maintenance and renovation costs, insurances, rates and all the other day to day expenses associated with owning property.
The difference is that you will be receiving rental income and reducing your taxable income. Your loan repayments are more likely to be interest only, a lower commitment from your fortnightly cash flow.
That’s just the beginning. If you’re in the Australian Defence Force, there is the temptation of buying a PPR in a location you’ve been posted to. It may not be where you would choose to live or invest otherwise.
Let’s take a closer look at how that might work.
Use your Defence Force entitlements to move you toward your goals
Housing benefits are on offer for your commitment to the Australian Defence Forces. These incentives can be attractive in the short term but is buying a PPR first in your best interest for the future?
I often chat with young Defence members who get seduced into building a serviceable home with some of the trimmings using their property defence entitlements to buy into the locality they’ve been posted.
Buying a PPR means loading up with bad debt. Bad debt is any debt that you pay interest on and is not going to reduce your taxable income. I get the appeal of wanting to jump in and buy a house to live in when you feel cashed up. I would be ecstatic if I could interrupt your flow of immediate term thinking and show you a more strategic, streamlined way. A way of setting yourself up with more freedom of choice in the long run.
My goal is to help you maximise your ability to invest and grow your personal wealth. I’m not going to tell you, I’d rather show you. So, let’s explore the numbers.
Learn how Defence Force members can use the First Home Owners Grants (FHOG) in Victoria and New South Wales for investment with the Defence Force Residence Exemption.
Breaking down the costs of buying your first home with incentives - your PPR
Imagine you’ve just been given the heads up on your new posting. You could use your Home Purchase Assistance Scheme (HPAS) or your Defence Home Ownership Assistance Scheme (DHOAS) in conjunction with the first home owners grant (FHOG) to purchase a property in your new digs.
The whole idea is enticing. Imaging owning your own home to live in with stone benchtops, new appliances and maybe even a glistening blue new pool to entertain all your oppos!
Here are some numbers.
* Figures were correct at the time of publishing this article (December 2018)
**After tax @ $80,000 p/a income
Looks great right?! And repayments are achievable. With interest rates still low it costs just as much to rent somewhere to live as to own - currently. So why not take the leap and buy your own home?
Let’s switch back to reality for a moment. This isn’t your dream home in your ideal location. Sure, you’re buying the property to live in for now, and then you’ll turn it into an investment property once you’ve seen this new posting out.
As a homeowner, you’ll be paying principal and interest repayments on a mortgage. You’ll also need to pay the property’s outgoings including the water rates, the council rates, insurances, and upkeeping the property - this can be a significant hit on your fortnightly cash flow. It will change the way you live, because you’ll need to tighten up.
Buying a PPR might be okay while interest rates remain low but what happens when there’s a rise? It is inevitable that interest rates will go up given their history of being at an all time low.
Here are some of the numbers.
Calculate cash flow impacts based on the holding costs of a PPR
*Purchase price – 10% deposit – Defence benefits [FHOG + HPAS]
That’s a total of over $30K to fork out each year, after tax – around $600 out of your pocket each week. You’ve just dropped your disposable income. With extra expenses to cover, your ability to borrow for a loan to start or grow your property investment portfolio diminishes. And, there are no tax breaks.
Consider this. The locality you’re being posted to may not be a great property investment area. There is likely to be far better areas to invest in.
An option may be to hold off buying your PPR for now, and rent. Keep your Defence entitlements and invest in a purpose-built investment property in a major capital city with good property investment criteria. There are localities where the rental income returns are attractive in the short and longer term; and the capital growth is healthy.
Rent allowance is a financial incentive that will put cash back in your pocket
Here is a summary I’ve worked based on the current Defence rent allowance. Below is a worked example (along with the previous one) of how you could cut your ~$600 per week housing costs to ~$230 per week. That’s an extra $370 every week back into your cash flow.
Breaking down the costs of buying an investment property first
Consider this option. Take the extra cash freed up through using your rent allowance incentive and invest in property in a research-driven way.
Leverage your deposit and your income into an investment property in a major capital city with sustained population growth. Research to find a locality that gives you a good supply and demand mismatch for the long-term. This will increase your investment roughly between 5 to 8% per annum and gives you great tax breaks. The property will be an income producing asset which can, in turn, increase your borrowing capacity so you can continue to grow your asset base.
Why not save your Defence entitlements until you work out where it is that you really want to live for the longer term. Invest in a residential property, and simply rent now with the goal of buying your dream home.
Like take away food, convenience in the moment is short-sighted, and doesn’t deliver longer term health benefits!
With a long-term view, crunching the numbers on the holding costs of an investment property is a completely different scenario from buying a PPR.
By investing in a property, you’ll receive a rental income and claim tax benefits – two sources of income!
When re-working the example of the $450,000 property we used in the PPR scenario, you'll quickly see the ongoing holding costs are considerably lower.
Calculate cash flow impacts based on holding costs of an investment property
*Please use as an example only
** Purchase price – 12% deposit [$54,000]
So, instead of costing you an additional $600 per week – you’d put $85 back in your pocket weekly! And this worked example doesn’t cover the capital growth that is going on from year to year, that you can then leverage to borrow for your next investment property.
Buying a property for investment first will enable you to continue your savings plan and leverage into your next property in a couple of years.
And, if the interest rates go up so do your tax breaks, and you can put your rents up too.
Show don’t tell. I’ll let you decide which is the better option!
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