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Why Renters Need a Long Term Plan

RentersWhy Renters Need a Long Term Plan

The rate of home ownership in New Zealand is falling. Just under 65% of households owned their own home at the time of the last census in 2013, and this is the lowest it has been since 1951. The rapid increase in property prices since 2013 has no doubt further eroded this percentage. The flip side is of course that more people are renting and either delaying the purchase of a first home or choosing to rent long term.

Affordability is only one reason people rent. Other reasons include the flexibility to be able to travel, the desire to live in a more expensive location, perhaps close to work or close to good schools which would otherwise be unaffordable, and freedom from the responsibility and cost of house maintenance. These are all sensible reasons to rent, however renting over the long term has serious consequences for retirement.

The fact is, NZ Superannuation is set at a level that covers basic living costs but not rent or mortgage payments. If you don’t own a debt free home in retirement, you will need a big chunk of money, probably at least half a million dollars, to finance your rent payments for the rest of your life. That’s around the cost of house in a mid-sized town.

There are two ways of building this wealth. The first is to save very hard out of income. The second is to borrow money to invest. Borrowing to invest only makes sense if you are investing in a business or in property. For most people, property is the easier option.

The answer’s obvious. If you choose to live in a rented home while you are working, play it safe by investing in a rental property, preferably in a location you would be willing to retire to.

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Why You Need to Own a House

HOUSE IN THE SUNWhy You Need to Own a House

The percentage of households who own their own home has dropped to the lowest level since 1951 according to figures released this year by the Department of Statistics. At the peak of home ownership in 1991 around 73.5 percent of households owned their own home; now that number is less than 65 percent. What we are seeing is increasing concentration of property ownership in the hands of a smaller number of people who own multiple properties.

Renters make the argument that being a tenant makes good economic sense. Rent is initially less than the cost of mortgage repayments. The landlord takes care of rates, house insurance and repair bills. Renting is more flexible – you can change location without incurring the huge costs of selling a property. It is hard to argue with these points if you take a short term perspective on the issue of renting versus owning.

Now let’s take a long term view. Over the long term, we know property prices increase, and along with that, rents go up. On the other hand, the amount of money borrowed to purchase a house either stays the same in nominal terms or reduces if the principal is repaid. The effect of inflation is to reduce the real value of the mortgage and the principal repayments over time. If house prices rise at higher percentage than the rate of interest on the mortgage, this effect is amplified. The sooner you buy a house, the more wealth you will create. Living in rental accommodation in retirement is not desirable. Rents increase over time and landlords cannot be relied upon to provide long term tenancies. Owning a debt free home leads to a much more comfortable retirement. The sooner you buy, the cheaper it will be and the more wealth you will create.

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Sweet Spot for First Home Buyers

SweetsSweet Spot for First Home Buyers

Proposed changes to the Reserve Bank’s restrictions on high-LVR residential mortgage lending could create opportunities for first home buyers outside the Auckland region. The Reserve Bank has released a consultation paper which proposes a tighter regime for Auckland and a more relaxed approach for other areas of the country. Currently, banks are subject to a ‘speed limit’ on lending whereby only 10% of new lending can have a loan-to-value ratio (LVR) of greater than 80%. The proposal is to increase the limit on high-LVR loans outside Auckland from 10% to 15% of new lending. This is estimated to lead to a 4% increase in the number of house sales and at least a 1% increase in property prices outside Auckland. Meanwhile, other proposed changes would see tighter rules in Auckland for borrowing by property investors.

At the same time, KiwiSaver balances are increasing and many potential first home buyers are finding their combined KiwiSaver funds available as a deposit for a first home, along with first home subsidies, are sufficient to meet bank deposit criteria. More homebuyers will be eligible if the proposed speed limit changes go ahead. As well as the available deposit, banks consider income and credit rating to determine your ability to make repayments within your income and on time. A high level of short term debt on credit and store cards and a poor credit rating can push people outside bank lending criteria. There is a sweet spot now for first home buyers outside Auckland to get themselves into a financial position to meet bank criteria and take advantage of low interest rates and possible changes in the speed limits to purchase before the market heats up.

The Reserve Bank will make a final decision in August, with new rules coming in on 1 October, 2015.

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Home Buyers Beware

Caution2Home Buyers Beware

New Zealand has a high rate of home ownership when compared to other countries, although it is falling. More properties are now owned by fewer people and property investors are becoming more influential in the market. Owning property can be a good way to create wealth as the value of property increases over the long term, however in the short term, property prices can fluctuate. The key drivers of property prices are interest rates, population changes (particularly from net migration) and the supply of housing. Other factors such as building costs and bank lending policies can also be important. Getting onto the property ladder can be a risky process. First homes are usually bought with a small deposit and a large mortgage at a time of life when income is low and uncertain. The key risks faced by first time buyers are the risk that interest rates will rise, thus increasing mortgage repayments, the risk that income will drop due to loss of a job or the birth of a child, and the risk of having to sell the property due to financial hardship at a time when property prices are falling. Right now, there are significant medium term risks for first home buyers. Interest rates are low and may fall, property prices are high, investors are very active in the market, and in some areas there is a shortage of properties. This is a dangerous combination. First home buyers who buy now face the risks that interest rates will rise, investors will pull back due to the high cost of borrowing, and the supply of houses may increase beyond the level of demand. Buyers who borrow cheaply now but do not factor in higher interest costs in the medium term may be forced to sell in a falling market.

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Structure Your Mortgage

Structure (800x600)Structure Your Mortgage

Buying a house is a lengthy, stressful process. Just when you think it is all over, and before funds are released to your solicitor, your lender will ask how you want to structure your mortgage. You will no doubt have had little time to consider this and yet the structure of your mortgage can have significant financial implications. Mortgages vary in terms of how repayments are made and how the interest rate is set. There are three basic types of mortgage:

  • Table mortgage. This is the most common type of mortgage, on which you repay both the principal and interest over a fixed period. You can have a floating interest rate or fix your interest rate for a period of time, giving you certainty of what your repayments are. Fixing can lead to penalties if you repay your mortgage earlier by increasing your repayments or paying lump sums.
  • ‘Interest only’ mortgage. With this type of mortgage, you pay back only the interest for a fixed period of time.  This is useful if your mortgage repayments are very high, if you have a sudden loss of income, or if you are buying an investment property.
  • Line of credit, or revolving credit. This type of loan works a bit like an overdraft. You are required to pay the interest owing on the balance of the loan each month. The interest rate is floating. You can reduce the amount of interest you pay by keeping your savings in your line of credit.

You can divide your mortgage into two or three different amounts with a mixture of types of mortgage and with table mortgages fixed for different periods. Your bank or mortgage broker can help advise you on the best structure, but don’t leave it until the last minute!

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The Importance of House Prices

house for saleThe Importance of House Prices

House prices are not only a key indicator of what is happening in an economy but they can also be a trigger for a change in economic conditions. Hence the state of the housing market comes under close scrutiny by the Reserve Bank and other Government officials. There is a very close link between house prices and inflation. This is understandable when you consider that the cost of a mortgage or rent is often the single biggest expense in a household budget. The Consumer Price Index (CPI) measures the changing price of a fixed ‘basket’ of goods and services purchased by households of which a weighting of around 13% is given to rent and house purchase costs. Any change in these costs therefore has a significant effect on inflation, which is measured by the CPI. As house prices go up, there can be other impacts. For existing home owners, there is what is referred to as a ‘wealth effect’. The increase in house values makes people feel wealthier which can cause them to borrow and spend more, thus adding to inflationary pressures. For first home owners, house price increases mean larger mortgages, with the risk that mortgage repayments may become unaffordable, especially as interest rates often rise along with house prices. If home buyers struggling with mortgages quit their homes in sufficient numbers, this can trigger a sudden drop in house prices and a downward spiral in which homes are sold at a loss. Such an event in the USA was a key trigger for the Global Financial Crisis. As the Reserve Bank of New Zealand continues to increase interest rates while maintaining its restrictions on low-deposit loans, it will be interesting to see what impact this has on the housing market. First home buyers should proceed with caution.

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Investing in Your Home

MansionInvesting in Your Home

Let’s get it straight; your home is not an investment. While property appreciates in value over time, the best property to own from an investment point of view is a property that produces rental income as well as capital gain. Investment is something that should be done with objectivity and a focus purely on investment return and risk. Buying a home to live in is a process clouded with emotion and consideration of comfort and lifestyle. The best property to buy as in investment is unlikely to be the one you would choose to make your home.

From a strictly investment point of view, the home you live in should be the kind of house that would make a good rental property; that is, at the lower end of the market in a handy location. Instead of investing a large amount of money in one property to provide a lavish lifestyle, buy two cheaper properties; one to live in and one to rent.

Those who choose to live in expensive properties often argue that the money invested in their home is in effect their superannuation plan. The idea is that on retirement the property will be sold, a smaller property purchased and funds released for retirement. Such plans seldom succeed. Retirees generally desire a small, relatively new, low maintenance property. These are often close in value to a large home that has been lived in for some years. Living in a high value home creates an expectation of a certain standard of living which is hard to forego.

Committed renters who argue that it is cheaper to rent a home than buy one will find that paying rent in retirement can cause huge financial stress. Invest in at least one house in your lifetime but don’t make it your only investment.

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Good and Bad News for First Home Buyers

newspapersGood and Bad News for First Home Buyers

Finding the deposit for a first home is a huge financial hurdle and around two thirds of first home buyers obtain a high loan-to-value ratio (LVR) loan. The LVR is simply the amount of lending compared to the value of the property, and an LVR of more than 80% is considered to be high.

Since October 1, banks have been required by the Reserve Bank to limit high LVR residential mortgage lending to no more than 10 per cent of new lending. There is speculation that in order to get around this limit, home buyers will use personal loans and loans from Australian second-tier lenders (who are not covered by the Reserve Bank’s restrictions) in order to come up with their 20% deposit.

On the good news front, changes to KiwiSaver and the Welcome Home Loan scheme come into effect this month to make things a little easier for first home buyers.

More KiwiSaver members will be able to access deposit assistance of up to $5000. That’s because the maximum joint earnings of a couple to qualify for the assistance will rise from $100,000 to $120,000, and the house price caps under which the assistance is available will also be lifted. In particular, the Auckland price cap will lift from $400,000 to $485,000.

The number of Welcome Home Loans, under which the Government underwrites loans for qualifying people, will increase from 845 to 2500.

Interest rates are expected to start rising early next year, and all home buyers should be leaving some wriggle room so that increased mortgage repayments will not cause financial distress. Before you commit, find out from your bank what your repayments would be if interest rates rose by 2% over the next two years and check your budget to make sure these repayments will be affordable.

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Invest in your Home

Invest in your Home

Your home is your castle, so they say, and if it’s not as grand as you would like, now is a good time for improvements. Why? Largely because of the state of the economy. On a long term scale, we are at an economic low point. Properties are difficult to sell at other than a bargain price, tradesmen are short of work, and interest rates are low. With the cost of borrowing likely to be low for some time, a good case can be made for renovating your home to make it larger or more comfortable rather than selling to upgrade. Negotiate a good price with tradesmen and suppliers to keep the total costs down and potentially you can add significant value to your house without having to outlay a large amount of money.

Now is also the time to take advantage of the subsidies available for insulating your home. Insulation has the advantages of making your home more comfortable and easier to sell with the added benefit of reducing your power bills. More information on home insulation subsidies is available here.  

There are some words of caution, however, if you are thinking of embarking on a renovation project. Strictly speaking, your home is not an investment; it is what financial planners refer to as a ‘lifestyle asset’. If you have spare funds, you can usually get a better return on your money by investing in assets which give you income as well as capital gain. If you need to borrow to do your renovations, don’t borrow so much that you are living from payday to payday to keep up with the mortgage payments. Finally, do your sums and check local property values to see if your resale value will improve by more than the cost of your project.

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Rent or Buy?

Rent or Buy?

Property prices have fallen significantly over the last two years making houses much more affordable than they have been for some time. Despite this, buyers are still in short supply. The most logical reason for this is that buyers expect prices to either continue dropping or to at least stay flat for some time. This creates a dilemma for first home buyers and people moving towns; is it better to rent or buy in the short term?

 Whether you are buying a property to live in or to rent to someone else, there are two factors to consider. The first is the extra income you will have if you buy, either because you are no longer paying rent or because you renting to someone else. The second is the capital gain you can expect from owning the property. Property prices are not expected to increase significantly over the next 3-5 years. At the same time, rents are still low in comparison with property prices. If you can rent a property for an annual rent of 5% of its market value, why would you borrow money to buy when the interest rate is around 7% and there is little prospect of capital gain?

 In the short term, with no expectation of property prices increasing, renting makes sense unless you can buy a property well below market value. For first home buyers, this allows more time to save a bigger house deposit and for others who have sold, it is an opportunity to temporarily live more cheaply in the kind of house that might previously have been out of reach to buy.

 In the long term, it makes sense to buy a property for security and peace of mind and to ensure you don’t get left behind when prices inevitably rise again.

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