Property ownership has been woven into the fabric of New Zealand society for many generations and the potential to own your own home has been a dream and reality for many young New Zealanders. The purchase of your first home is emotional and in equal parts exciting and daunting, but is now a good time to buy your first home?
The excitement comes from buying a property where you will create a stable home environment, be part of a community and will create many lasting memories. Undertaking one of the biggest financial transactions of your life and the pressure of having to pay a mortgage every month can be daunting.
How much money you are prepared to spend on your accommodation – whether it is a mortgage or rent – will determine the quality of your accommodation and will be an important factor in your quality of life both now and in the future. There is a trade-off between saving now and your quality of life when you get older – make sure you leave enough money to enjoy today but don’t forget about tomorrow.
Renting may be cheaper in the short-run but it’s not that simple when you are embarking on your life journey and buying your first property is a part of that dream. Remember, property is a long-term investment so what could buying a property look like after one, five and 10 years?
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The below example walks you through the financial implications of buying your first home – it’s not simple but stay with it as it will be one of the biggest financial decisions you make in your life.
Let’s run the numbers. The model below assumes a house purchase of $600,000 with a 10% deposit, an interest rate of 5.99%, and inflation of 3%, which has been applied to all aspects of the model – capital gains, rent, and expenses. To build a model that is more relevant to your situation change the inputs as appropriate. To re-calculate the mortgage interest and principal based on your loan and repayment terms you can use the mortgage calculator on sorted.org.nz.
In this example we can see that we are going to spend $50,000 on home ownership costs in the first year. If we were renting, we could be paying $26,000 (around $500 per week) so it looks as though it costs us an additional $24,000 to own our own home.
Notice how the amount you spend on home ownership doesn’t change much over five and 10 years. This is really important as buying a property effectively locks in the cost of your accommodation for the length of your mortgage or until you want to upgrade your property. The big prize in home ownership is when you pay off your mortgage and your interest and principal repayments become zero.
The important variable here is interest rates, but these can be managed by splitting your loan so interest rates are being renewed after say one, three and five years. This smoothens the change in interest rates that you will experience, as only one third of your mortgage will be up for renewal at any point in time.
The cost of owning your home isn’t quite as simple as deducting rent from home ownership costs as you are making principal repayments against your mortgage. If we think of the principal repayments as long-term savings, then the true cost to us in year one is $14,400 and by year 10 we are almost breaking even.
The benefit of principal repayments is that over time they reduce the amount of your loan and reduce the amount of interest you have to pay, which increases the amount of principal you repay – effectively they help you own more of your home. Here, after 10 years we have paid off $128,000 of our mortgage and we now owe $412,000.
Historically house prices have increased, and while there is no guarantee that this will continue to happen in the future let’s make the assumption that they continue to do so at 3% per annum. After five years the property could be worth $696,000 with a capital gain of $96,000. After 10 years the capital gain could be worth $206,000.
If we take our hypothetical property value after 10 years ($806,000) and deduct the mortgage value ($412,000), then we have theoretically built up equity in our property of $394,000. This isn’t free money as you have been paying more to own your home than you would have been renting, but it’s still pretty good.
What you are doing by buying a property is creating a home and certainty around where you will live and how much you will be paying for your accommodation each month.
Don’t give up on your dream. Work out how much you are prepared to pay for accommodation and maximise how you use that money.
- Glenn Dunn-Parrant has been investing in property for 30 years and works for NZME
