Australian Financial Review Smart Invester – 3 September, 2014
Andrew Crossley
The question of which is superior, buying or renting your home, is one that is not as common as some might think. But we think it should be.
Emotion is a powerful thing and more often than not eclipses pragmatism. The Australian dream has always been to own a house, pay it off over 30 years and live debt-free in retirement. But what then?
While the dream has been to own a house, the reality is that very few actually end up living in their dream home. Selecting a property to live in is rarely a commercial decision-making process.
The considerations for the location of where someone wants to live are not driven by capital growth potential or yield, it is more emotional, such as school for the kids, near friends or family maybe and near place of work. This is generally not a financially smart move.
People like to own a house so they can do what they want to it. It provides a greater sense of freedom, particularly if they work for someone rather than being self-employed.
It is nice to be in control of your home life if your work life is largely dictated by someone else. However, this doesn’t always turn out well.
Too many people buy a house and end up with a large mortgage weighing them down for years.
Generally, people take out home loans close to the threshold of what they can afford rather than leaving some room in their borrowing capacity in order to build wealth by investing in property or shares.
An owner-occupied mortgage is bad debt; it provides no tax deductions, must be paid entirely out of the owner’s pocket, and has no rent coming in to assist.
It normally lacks the desired amount of potential for capital growth compared with a well-purchased investment property.
A home loan debt will also dramatically negatively impact on the ability to borrow, let alone borrow to buy an investment property, certainly for several years for many people. In fact, if your goal is to build wealth the decision to buy rather than rent can be counterproductive.
If wealth building is the primary objective, it is better to buy an investment property instead of a home to live in because the taxman and a tenant help pay for the property.
Investment debt is good debt
Investment debt is known as good debt, as it provides tax deductions. Many lenders add the interest (deductible debt) back into the investor’s borrowing capacity calculations, and this seriously improves the amount a person can borrow.
Interest rate rises matter less as tax deductions and tax deductibility on a lender calculator could rise, and the rent the tenant is paying may be increased.
In a rising interest rate market, rent tends to trend upwards. Additionally, if the investor has purchased well, this will happen anyway due to supply and demand.
Renting and investing provides greater ability to get into the market and on the way to creating wealth, while allowing greater freedom and flexibility to rent in an area where the investor could not normally afford to buy.
Hopefully, the applicant has been smart enough to not pay an excessive amount of rent just to live in a postcode that makes them feel more important.
When someone rents, the landlord pays the insurance, rates and body corporate, if any. The landlord pays to fix things and for the upkeep.
The tenant, therefore, can save more money to invest, compared with living in a property they are on the title of with a mortgage against the title.
Any good mortgage broker should be able to spell out just how much easier it is to buy an investment property than a home.
The upshot to all this is that instead of focusing on the difficulties of first-home buyers, who often struggle to get a toehold in the market, perhaps you should be considering property investment as a way to get your foot in the door to start with.
That way, if you feel compelled to buy a home of your own when children arrive on the scene, you will hopefully have already created enough equity in your investments for a deposit on the property you truly desire.
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