Bank on getting a foot in the door

Unless you're disciplined and patient ... the brutal truth is you're not going to finish up with an asset by renting.

The system is geared towards the concept of home ownership, says David Potts. He has some valuable tips for first-home buyers.

Buying beats renting a home for building wealth. Not that there's any rush. So don't be spooked by the hype about auction clearance rates. The fact is, vendors are being realistic - rising unemployment will be a dampener on the market, inflation is barely visible, and the banks can't give away loans because debt has become a dirty word.

Without borrowing to sustain it, there can't be a boom. Besides, supply is increasing as new construction picks up.

By rights, property prices should rise by the increase in national income, or nominal gross domestic product, which, if Treasury is right, will be 4.5 per cent this financial year, although admittedly, averages don't preclude hot spots.

So you need to get real before getting realty. Most home owners think renting is dead money. I wonder what they'd call council rates or the inevitable maintenance? And having an agent only a phone call or three away who can fix things must be worth something in busy lives.

Best of all, renting is cheaper.

But unless you're disciplined and patient enough to invest what you'd be saving by not having a mortgage - much easier said than done - the brutal truth is you're not going to finish up with an asset by renting.

Frankly, it's the forced saving in owning a home that's the clincher. Anyway, the system is slanted towards buying a home, so if you can't beat it, why not join it?

There are grants galore and stamp duty concessions to help you buy. Your home will be free of capital gains tax when you sell, there's nothing like a mortgage to keep you on the financial straight and narrow, and when you retire, it will be ignored in Centrelink asset tests.

First-home buyer grants for building a new home vary between states. New South Wales and Queensland are the most generous, offering $15,000, while Victoria pays $10,000.

So what's the best way to save?

It's hard to go past the first-home owner savings accounts, although many do. Perhaps that's because these accounts aren't easy to find. The big banks gave up on them some time ago, apparently because too many customers complained about being locked in for four years.

But they're the best way to save, because the interest is separately taxed at only 15 per cent instead of going in your tax return, and, better still, the government contributes another 17 per cent to whatever you deposit up to a cap of $1020.

So on a $6000 annual contribution, you'd be earning about 20 per cent, of which only a tiny part is taxed. Each partner can have an account as well for the same deal. And don't bother with the big banks. Most mutual banks and credit unions happily offer them.

But what was that about being locked in? You have to deposit at least $1000 in each of four financial years. Worse, if you decide not to buy, the savings will be transferred to your superannuation, where you won't see them again for the rest of your working life.

Your first property almost certainly won't be your last. That's why first-home buyers often settle for something that's not quite what they want, but they get a foot in the door, so to speak.

Here's a tip for the auction. Rather than, say, pay the penalty for breaking a term deposit or having to sell shares at the wrong time, consider deposit bonds. These are offered by banks and finance and mortgage specialists. They provide the 10 per cent deposit you need, for an upfront cost of between $300 and $600. The beauty of a deposit bond is that you can use it at any auction without having to get a bank cheque in advance.

But before you head off to the auction or make a down payment, get your mortgage pre-approved by a lender.

"For at least six months, your finances have to look squeaky clean," says Tony Harris, founder of The Money Store.

"Just missing a payment on a credit card will be a cross against you when the lender scores you for a loan."

"Put aside regular savings, even if it's just $50 a week," Harris says. "Lenders love to see someone with financial discipline."

There's no secret technique to bidding successfully at an auction, apart from offering too much.

While I can't vouch for this, agents tell me being the first and last bidder, and doing nothing in between, can rattle other bidders.

Which brings me to the mortgage.

Judging by the recent warnings from the Reserve Bank, lenders are becoming less strict about loan valuation ratios, but you should be.

If you have a deposit of 20 per cent or less for the amount you want to borrow, you'll be up for lenders' mortgage insurance.

For example, a $316,000 mortgage on a $350,000 property purchase - a loan valuation ratio of 90 per cent - would cost $8349, according to information online from mortgage insurer Genworth. That will wipe out half the first-home buyer's grant.

Lenders will spread this over the life of the mortgage, so it will add only a little to monthly repayments, but over time you'll be paying interest on it.

Incidentally, your lender will make an allowance for at least a 1 per cent rise in interest rates to work out your eligibility.

There's a 2 per cent difference between the lowest (4.49 per cent) and highest (6.50 per cent) variable rates on offer. On an average 25-year $300,000 loan, the highest would add $360 in monthly repayments, or more than $100,000 in extra interest.

Still, the cheapest may not be the best. A cheap-as-chips home loan of 4.5 per cent will help make it more affordable, but you're not going to be able to pay it off faster.

The same can be true of fixed-rate loans, although many lenders will allow extra repayments up to an annual limit.

Fixing the entire loan is a bet against the banks that many borrowers have subsequently rued. Even so, with one, two and three-year fixed rates below 5 per cent, it's a cheap price to pay for the certainty of knowing exactly how much you'll have to pay over that time, especially when the smart money is predicting rates will start rising again about the end of next year.

If you go wholly or partly with a standard variable loan, get one with a mortgage offset account, even if it costs a little more. This lets you make extra payments, reducing the interest, which you can always take out again any time at no cost.

Shop around or use a mortgage broker who will not charge a fee but will be paid commission by the lender you sign up with.

The banks are discounting loans by up to 1 per cent to get good customers, and mortgage brokers in effect knock a bit more off by rebating some of the commission they receive.

Watch Money's John Collett and David Potts discuss the best routes to property success at theage.com.au/money.



Couple opt to work their way up market

As you'd expect of an accountant, Michael Trajkovic methodically applied financial analysis to buying a home, down to the precise proportion of the loan that would be fixed.

After looking at "three or four dozen and visiting at least 24" properties, Michael and partner Krystina Tsatsoulis, both 25, decided it was best to settle for somewhere cheaper in the outer suburbs, so there was a smaller loan and they didn't have to pay mortgage insurance. Contrary to popular belief, mortgage insurance, which usually kicks in if you're borrowing 80 per cent or more of the value of the home, is for the lender, not you. Depending on the size of the mortgage, it can add tens of thousands to the cost.

"We don't have to pay mortgage insurance," Michael says. "We could have got a bigger loan and somewhere closer to the city or work, but we decided we didn't need what we want at this point. It was better to move further out and be closer to family, buy cheaper and be easier to pay off."

The plan is to upgrade to something bigger and more suitable as a dream home in a few years, and using this property as a rental. "If we move out, the rent would cover the interest," Michael says.

That's why they've chosen an interest-only fixed-rate loan for two years at 4.79 per cent, which was arranged for them by Mortgage Choice.

Michael says 87 per cent of the mortgage will be fixed, a figure derived from his wanting to keep $40,000 at the variable rate of 5.08 per cent, complete with an offset account. "I can put money into the offset account to reduce the variable component," he says.

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