Wealth creation starts with the first home, say planners
With home ownership among younger people in decline, where does that leave their prospects for wealth creation?
The answer is not good for those struggling to gain a foothold in the property market.
There is ‘‘no question’’ that home ownership has added enormously to the personal wealth of most Australians, says John Hewison, a financial planner and founder of Hewison Private Wealth.
And those permanently locked out of the market will be forgoing the wealth creation advantages that their home-owning parents enjoy, financial experts warn.
Part of the advantage of home ownership flows from the substantial tax breaks.
Successive governments have supported home ownership through favourable tax and social security treatment of the family home. The family home is exempt from capital gains tax when the owners sell and upgrade. And later in life, the family home is exempt from the assets test which, together with the income test, determines the amount of age pension that is paid.
A recent report by the Grattan Institute found home owners receive about $36 billion a year in government expenditure and property investors almost $7 billion.
By contrast, private renters receive very little support through the tax and welfare system, even though they make up nearly one in four households.
Of course, home ownership is not all about money. There is the security of owning your home, especially in retirement. For those in retirement who do not own a home there is a lot of stress over where they will live, says Laura Menschik, a financial planner with WLM Financial Services.
Renting in Australia is more uncertain than in some other countries because the lease terms are typically only six or 12 months. The short tenure of rental contracts adds to the concerns of renters about landlords giving notice or increasing the rent.
Paying off a mortgage is forced savings, says Andrew Heaven, an AMP financial planner with WealthPartners Financial Solutions. That can be particularly helpful to those who have difficulty saving.
‘‘Over time, once the mortgage is substantially reduced, it becomes less of an expense than rent, which rises faster than inflation,’’ says Mr Heaven.
The family home then becomes the ‘‘engine room’’ for further investing. Equity in the home can be used as security to borrow to invest in shares, property or managed funds. And the borrowing is at mortgage interest rates, which are going to be much lower than other loans such as personal loans.
Owners can make improvements to their properties and add value. Home owners who make further investments have the opportunity for another bite at the cherry, courtesy of the tax breaks on investments. Under ‘‘negative gearing’’, if income from the investments, such as rent or dividends, does not cover the interest costs and other expenses of making the investment, the shortfall reduces the investor’s income on which income tax is paid.
With a mortgage, the pain is early on. Those with mortgages under control are likely to have the spare cash to be able to start or increase salary sacrifice contributions to superannuation, which, like property, is tax advantaged.
Mr Hewison says the advantages of home ownership in wealth creation underline the importance of getting onto the property ladder. But first timers may have to lower expectations if they are to get a start.
Mr Heaven agrees. ‘‘Our parents were not looking to buy [their first home] within five or 10 kilometres of the city centre,’’ he says. ‘‘A bit of expectation modification would probably not go astray.’’
But while the advantages of home ownership are clear, it should not come at the cost of mortgage stress. Mr Heaven’s rule of thumb is that mortgage repayments should not be more than 35 per cent of the borrower’s gross income.
In addition, buyers should be able to put down a deposit of at least 20 per cent of the price to avoid paying lenders’ mortgage insurance.
The premium for the insurance runs to thousands of dollars. While it is paid by the borrower it covers the lender if the lender has to sell the house and there is a shortfall. It is a one-off premium that lenders add onto the loan.
Mr Heaven prefers first timers to have the full the 20 per cent deposit to show a good savings discipline and that they will be able to manage the mortgage repayments. It also gives borrowers enough equity in the property for some ‘‘breathing space’’ if property prices fall.
Planners say that for those for whom home ownership will likely continue to be out of reach, the best way to close the gap on home owners is to make salary sacrifice contributions to superannuation. Younger people have a cap or limit on how much they can salary sacrifice in a financial year of $25,000. The cap includes the 9.25 per cent compulsory superannuation.
By salary sacrificing, for the vast majority of salary earners, the income tax that would be paid on each dollar sacrificed is replaced by the 15 per cent super contributions tax. And once inside super, the money receives further concessional tax treatment.
Arranging for a set amount of pay to be sacrificed into super is easy to do and great way to save, says Ms Menschik. Also, superannuation savings can be used by renters to pay for a life tenancy in a retirement village or complex.