Buying my dream family home 5 years before I needed it saved me $275,000

buying my dream family home orange wealth

August 05, 2016 Buying my dream family home 5 years before I needed it saved me $275,000

When I think about my family home, the saying, “Don’t put off until tomorrow what you can do today,” comes to mind.

The purchase of our family home is hands down, the best financial decision I’ve ever made – but in today’s housing market, it’s not easy.

As a kid, I remember running around my family house with my brother and sister and those memories are still with me today.

Just after my wife and I married in 2009, I started thinking about how I wanted my family to live. Where would we would create our own memories, just like the ones I enjoyed growing up?

Two things preyed on my mind: how I was going to afford to buy our home with a potentially large mortgage hanging over our heads? And where did I see myself in the next few years career-wise? Was I happy to continue working in my intense corporate career if we were to soon start a family?

At the time, the ultimate goal was to be able to afford our dream family home and not have a significant mortgage hanging over our heads.

So I researched online and found heaps of commentary on investing through shares and property. My approach was to quickly grow my wealth over the next five years so I could eventually buy my family home.

Luckily for me, my brother Jason is a financial adviser.

I talked through my plan with Jay and he turned it on its head. He simplified the whole process for me. He outlined what I could do to attain our dream home using five smart financial tactics.

Jay’s advice: instead of waiting five years to buy our home, he advised me to buy it now and to pull on all the financial levers available to pay down the home as fast as possible.

So that’s what I did! And if this approach is right for you, I believe that you can do it too.

I’d have to say the path we took in buying my dream family home five years sooner than expected, might be – at first glance – an unconventional one. But I’d like to share what I did with you in the hopes that you can realise the dream of buying or upgrading to your family dream home sooner too.

The Benefits of Buying a “Family Home” as an investor

Housing affordability, rising house prices and rents in Australia attract lots of debate and media coverage.

In particular, it seems these days you can’t watch or read the news without reports of Melbourne’s booming property prices. Melbourne’s suburbs continue to experience significant growth and this is across both ends of the property market spectrum.

Depending on whether you’re buying or selling, it can either be a potentially lucrative or incredibly stressful time looking for something to buy that you can afford.

It’s in the backdrop of these types of figures that my family took the plunge to buy our family home initially as an investment property. The tax concessions afforded to investors would greatly help us pay off our debt and help us move into our home sooner.

So, imagine a scenario where you’ve made an investment purchase on the property you plan on making your family home one day.

Tactic 1: Make negative gearing work for you

Tax reform was a big issue during the recent federal election campaign.

Specifically, there were calls for restrictions to the negative gearing policy and a cut to the Capital Gains Tax (CGT) discount. However, since the Coalition secured power, federal Treasurer Scott Morrison has flagged that any existing tax concessions won’t be changed at all. This is good news to Australia’s 2 million landlords.

So my advice would be: use these current regulations and tax concessions to your advantage.    

Simply defined, negative gearing means that the interest (and other expenses like rates, management fees and maintenance) you are paying on your investment property is more than the income (rent) generated. As a result, your investment is making a loss, for which the government provides generous tax concessions.

If you negatively gear, you’re able to claim your loss to reduce your income tax.  So for example, if your property reports a loss of say, $15,000 and your annual income is $100,000; your taxable income is then reduced to $85,000.

Tactic 2: Get down with depreciation

We all know that if you own a car for work, you’re able to claim depreciation on your vehicle against your assessable income. It’s the same with your investment property. Claiming depreciation on your property can potentially save you thousands.

As a property investor, you can claim depreciation on the cost of the building itself (Building Allowance), such as concrete and brickwork and the items within the property, such as ovens, dishwashers, carpet and blinds, etc. (known as depreciation on Plant and Equipment). 

In order to claim depreciation on both, your property needs to have been built or renovated after July 1985.  

Tactic 3: Rent it out

The next important factor to take into consideration is the rental yield you can expect on your investment.

It’s typically between 3 and 5%. Some suburbs in Melbourne do better than others, however, with some properties yielding more than 6% annually.

The Benefits of Buying Today

Right, so we’ve looked at the possible advantages of buying your dream home as an investment. So let’s take it one step further and look into the ways you can use this to help pay off your future home.

Tactic 4: Lock it in Eddie!

There’s probably no greater endorsement for my brother’s home buying strategy than being able to lock in a price five years sooner than I had expected to.

House price growth has increased about 7.25% per year over the past three decades and in 2016, so far Melbourne has seen a growth of about 13%.

Had I followed my original investment and waited those five years to buy, I don’t think I could have afforded to buy the home we live in today.

Tactic 5: Defer the pain of paying for capital gain

Capital Gains Tax (CGT) is the tax applied when you sell an investment and make a capital gain or profit.

Family homes are exempt however because the property was initially an investment, it does apply for the period I rented it.

This is the real kicker in our home purchase strategy.

Usually, if you purchase an investment outside of your family home, you’re liable to pay capital gains tax. Even with the Capital Gains Tax (CGT) discount, you could still end up having to pay thousands.

But imagine you’ve purchased your family home as an investment. If you plan on living there for, let’s say 20+ years (which my family intends to do), then you’re effectively deferring that payment for the time you live there.

But say you never plan on selling. You’ll never be obligated to pay CGT.

So how do you save $275,000 and pay down your loan faster?

OK, so we’ve gone through the five different tactics that can contribute to your buying your dream home sooner than you think.

But how does it all work?

What I’m about to detail is exactly the strategy I employed to secure our family home. However, if you’ll allow me a bit of mystery, I’ve decided to keep the suburb and purchase price of our home under wraps.

Instead, I’ll illustrate the process using a hypothetical Melbourne property – you’ll need to plug in the figures which fit your circumstances.

So for this scenario, imagine you’re looking to buy a property for $1 million. This isn’t so farfetched given the median house price in Melbourne now sits at $725,000. In fact, as of June this year, 90 suburbs across Melbourne recorded property sales of more than $1 million.

Step 1: Organise your deposit and loan

For the purchase of our new family home, I used equity I had built up in my existing home. This provided a 20% deposit, after which I borrowed the remaining 80%.

This allowed me to borrow the entire cost of the home including the fees.

Some of you may be thinking, “Isn’t that a risky move?”

It definitely has the potential to be risky if you don’t have a clear plan on how you’ll pay it back, but we’ll come back to that shortly.

Back to our scenario.

On a purchase of a $1 million property, if you were to borrow 100% of the purchase price, and taking into account the fees, you’d be looking at a total loan of $1,057,500.

Now imagine taking out a loan at today’s interest rate of about 4 – 5%. The worst case scenario is that you’ll be repaying a massive $53,000 in annual interest payments to maintain the loan.

That is an astronomical amount of money. Let’s see what you can do to offset that.

Step 2: Rent it out

Here we have a scenario where you’ve purchased your family home for $1 million but you’re likely facing some hefty interest repayments.

One way to dramatically reduce this: we turn to tactic three and rent out your house.

Let’s say you’ve bought in a suburb like Brunswick, which according to REIV, yielded about 3.5% rental return. The likely annual rent on a house in Brunswick would be about $32,000.

With this rental income helping to pay off the interest, your annual shortfall reduces from $53,000 to $21,000. That’s a huge reduction of about 40% to keep your house each year.

Step 3: Take advantage of tax deductions

Here I would use tactic one: making negative gearing work for you.

From our scenario, we’ve made a loss of $21,000 as the rent doesn’t cover the loan interest repayments. We can claim this loss to minimise our income tax.

We can also use to our advantage tactic two: depreciation.

I’d recommend getting a depreciation schedule (which is 100% tax deductible) to see where you can make further tax savings.

In the case of our house, an extension was built in 2001 and because I had a depreciation schedule, it allowed me to reduce my taxable income by a further $10,000 at tax time.

When I combined the tax deductions of negative gearing and depreciation, I was able to reduce my taxable income $31,000, which was no small feat.

Say your income attracts a 37% tax rate. You can potentially get a $11,500 refund from the ATO.

Back to how these deductions help to minimise the costs of keeping our $1 million family home.

We had a shortfall of $21,000, but being able to reduce our tax debt through negative gearing and depreciation could potentially pocket us $11,500. The amount of keeping the house now becomes $9,500 per annum.

If you think about that amount – $9,500* – from our original possible monthly loan repayment of $53,000 – you can save a staggering amount of money!   

*Note: I have not included maintenance or fee\tax expenses in the cost to hold – this varies too much between properties to calculate.

Step 4: “Lock it in, Eddie!” – Locking in your home in today’s prices

As I wrote earlier, the past 30 years has seen an average house price growth of about 7% per annum.

Even if we’re conservative in that figure, we can expect house growth to be at least around 5%.

This growth – while obviously a positive thing – can make it difficult for you to afford your dream home the longer you leave it.

If you’re buying your million dollar property which grows about 5% per annum, it’ll be worth in the vicinity of $1.275 million in five years’ time. That’s potentially an additional $275,000 you could save if you buy your family home five years before you need it.

Step 5: Come up with and stick to plan to pay off the loan

Not wanting a huge mortgage hanging over my family, I went about structuring the family’s income to plough as much as we could into paying off the house over five years.

Of course, your ability to do this will depend on your own family’s personal circumstances, especially whether the extra financial commitment would put too much of a dint into your family’s quality of life.

However, I believe the short term sacrifice is worth it.

We were able to pay an extra $20,000 a year over five years, shaving $100,000 off our loan.

So, if the purchase of your family home is an upgrade, you can use the equity you’ve built to reduce your new home’s loan.

For example, we were also living in a small inner-city house which had accumulated capital growth. It was valued at about $500,000 before our purchase. When we sold it five years later, it was valued at about $640,000 – of which my equity stood at $400,000.

Let’s look five years into the future…

Last week we finally moved into our dream family home. The kids love the space and you love the neighbourhood.

Over the past five years, the home we bought for $1,000,000 grew by $275,000 and the tax concessions made it easier to afford as well as allowing us to pay a chunk of the mortgage off prior to moving in.

We sold our small house and used the equity to pay down the mortgage to a manageable level.

Is this strategy for you? Well it really depends on your situation.

I have to say that this financial decision – which might be read at first as a little risky or unconventional – has lead my family and I to be living in our dream home.

Making this house purchase also proved the catalyst to change careers and start a family business with my brother.

The advice I received was, without hyperbole, life changing.

It’s what made me want to help ordinary families achieve their financial dreams, like I was able to.

I’m living proof that with the right tailored advice, you can buy your dream home sooner. I hope sharing my experiences gives you a different perspective on how you can move towards buying your own dream home.

To chat more about buying, upgrading or downsizing your family home, email me or schedule a call below:

Disclaimer: all information contained within this article is of a general nature. It does not take into consideration your personal financial circumstances. Please consult a professional financial adviser (just like us 🙂 ) when making a financial decision.
Michael Chew
michael@orangewealth.com.au

Hi, I'm Michael!I'm a Dad, writer and finance expert.My priority is making the most of what I have for my family and finding the balance between all of life's competing priorities.

4 Comments
  • Kate Riordan
    Posted at 10:20h, 09 August Reply

    Great article and good advice..if only we had met 10 years ago!!!! I would be living in a mansion now. Thanks for sharing

    • Michael Chew
      Posted at 11:38h, 11 August Reply

      Thanks for the comment Kate. It’s the next 10 years which count!

  • Bill Spiek
    Posted at 11:37h, 09 August Reply

    Great read, thanks for sharing this strategy!

    I have a couple of questions. You mention renting out the house whist you plan to live in it in the future. You are rewarded by negative gearing, depreciation and other tax goodies offered by the Australian Government during the rental period. Once you decide to move in, your advice on “never selling to avoid CGT” sounds a bit restrictive. Say l rented out for 10 years, got a capital improvement of $1m, if l sold it at the end of the 10 years, then l would be liable for $250k (with 25% CGT tax discount) . In the same scenario, what would be my CGT payable if l was to live it in for an additional 10 years after the initial 10 year rental period. Say the capital improvement is now $2m after 20 years. How much would be be liable to pay in this scenario? Also, if l did not sell the house, is this deferring the CGT event to my children when they inherit my estate?

    Thanks, Bill.

    • Michael Chew
      Posted at 12:10h, 11 August Reply

      Bill, Thanks so much for your questions.

      1) The ATO’s CGT rules provide a 50% CGT discount if you hold the asset for longer than 12 months. In your example, if your investment property had a capital gain of $1m after the CGT discount it would be assessed at $500k.

      https://www.ato.gov.au/General/Capital-gains-tax/Working-out-your-capital-gain-or-loss/Working-out-your-capital-gain/

      2) In the scenario where you rented it out for 10 years prior to moving in for 10 years, with a capital gain of $2m. You would essentially pay the same. The CGT would apply on $1m and you would get the 50% CGT discount so it would be assessed at $500k.

      3) In an inheritance scenario, the ATO still receive their money. Simply put the CGT liability would transfer to them if they sell it.

      My story was a specific example however, I understand everyone’s situation is different. If yo’ur trying to work it out feel free to give me a buzz or email – happy to have a chat over the phone with you.

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