'Bad parental advice' foils first home buyers' strategies

Andrew Zbik, senior financial planner at Omniwealth, stressed the importance of keeping emotion out of investing, sometimes over parental advice by highlighting his experience dealing with a couple.

He recounted the couple was told by their parents to get a mortgage, buy a home and pay it off as soon as they could, which was a small two-bedroom apartment in a block built in the 1930s.

“Lots of character but not suitable for them and the extra two children they now have,” Mr Zbik said.

“Two years ago, they moved out to rent a larger home and have been renting out the apartment since.

“For the home they paid around $500,000 over a decade ago – today it’s worth $1 million. The remaining mortgage is $200,000. That was good parental advice to follow.”

It became apparent that this couple needed a bigger home.

“Their parents are saying to them, ‘Buy a new home and keep the apartment for a long-term investment. Why would you sell the apartment? That’s a crazy idea. It’s cash flow positive’,” Mr Zbik said.

“This is where good parental advice turns into bad parental advice.”

By following the parental advice for a second time, Mr Zbik calculated the couple could borrow a maximum of approximately $1.85 million.

The original apartment still has a loan of $200,000 outstanding. Its annual cash flow brings in a positive $10,932, or an additional $210 per week. By holding onto this apartment and then applying for a new home valued at $1,500,000, the couple will need to take out a loan valued at $1,585,000 to cover stamp duty, purchase cost and loan establishment fees. The mortgage, assuming principle and interest, would result in $93,596 a year. Coupled with other rates totaling $3,760, this results in $86,424 over the year, or a cost of $1,872 per week

Despite the gained equity, the couple would need to pay $1,662 per week.

With long-term average interest rates of approximately 7 per cent, this will mean $3.796 million in principle and interest repayments over 30 years, which translates to about $6.274 million pre-tax to pay it all off.

However, by defying the parental advice and selling the apartment instead of continuing to hold it as an investment property, this would result in about $775,000 after fees and putting it towards the mortgage of a new house.

“As this was their original home, and they have been renting for the last two years, the sale of the property is still capital gains tax free (CGT),” Mr Zbik said.

“There is a rule that if you sell a property that was originally your home and you have been renting another property to live in that you do not own, you can sell that property CGT free for a period of up to six-years after moving out,” he explained.

By putting the sale of the apartment towards the new home, the couple would be left with a loan of $805,000. With the same mortgage and rates, Mr Zbik calculated this would result in a cost of $51,217 a year or $985 per week, saving $667 a week.

Now, the loan will require a total of $1.928 million in principle and interest repayments, meaning the couple needs to earn about $3.186 million over 30 years pre-tax.

“Importantly, they now have plenty of equity in their new home,” Mr Zbik said.

“If suitable, they can draw on this equity to purchase new investment assets. If the new debt secured against the home is used for investment purposes, this will then be tax deductible debt.”