Saving For Your First Deposit

We receive quite a few messages from first home buyers who are looking to enter the market. Sometimes they don't quite have enough to cover associated purchasing costs so this post will cover some ways of saving that often people don't think about or do very well. While some may seem obvious, many of these things are easily forgotten. So we hope this will serve as a refresher or maybe even teach you something new.

As always it's very important to ensure that anything you read with regard to property purchasing or indeed, any sort of financial advice, is taken in context of your own personal situation and risk profile - including the information you're about to read. We are not financial advisers, just providing some of our own thoughts and opinions. Remember what works in a general context and has worked very well for a lot of buyers, myself included, may not be the best for everyone.

Before we get into savings and planning tips, we should note that the NSW government has only just announced signifcant changes for first home buyers in relation to the traditional cost of stamp duty which has always involved a huge chunk of cash that buyers must pay up front in addition to deposit. This change means many FHBs will now have a choice to pay an ongoing land tax instead of the up front stamp duty, which is going to be a huge change for the FHB market and the amount of cash needed prior to purchase. However, while this is one lump sum of a savings requirement eliminated for many first home buyers, please consider the options prior to deciding which way to go - something for another post.

Everyone's life situation and investment goals are different and you should first consider your position with respect to these when deciding how aggressive or passive you want to be with your financial strategy. Increasing your cash balance requires one of two things (or a combination of both); cutting costs, or increasing revenue. Sounds like business talk? It is! To become successful in property investing (read: wealth creation) or property purchasing, you must first think of it like a business and develop good habits, whilst possibly breaking bad ones.

As humans, we are creatures of habit and resist change. However, the good news is that this trait can actually be used to your advantage. Once you overcome the bad habits and create new ones that positively impact your financial goals, you'll discover it's actually not that hard to maintain. When you speak to people who have turned their finances around, they report that seeing their savings grow actually gives them the exact same pleasure 'hit' that causes people to engage in the retail therapy that causes the problems in the first place, but with a more positive result!

1. Spend less than you earn. This sounds simple enough until you realise that most people generally know what they earn, but have no idea how much they're spending.  For example, spending $4.00 per day on a coffee equates to $1,460 a year. This means that (assuming a 32.5% marginal tax rate), someone would need to earn almost $2,200 a year just to pay their coffee bill. If you're earning say, $70,000 a year, this is about 3% of your gross yearly income just to buy coffee (and that's if you can even find it for $4 these days)!

Expanding on the above, people also tend to think in gross figures for earnings and net figures for spending, which isn't really a good way to think about it. The tax gap makes up the difference of course, but if you think you're earning $100,000 a year and that TV is costing you $1,000 then think again. In reality (after tax), you're only earning $77,000 a year for a TV that is costing you $1,000. Of course, tax rates can vary with deductions and other factors, but it's very important when you consider your spending that, unless the item is a tax deduction itself, you're comparing net earnings to net spending.

Add in any number of discretionary spend items, plus the cost of living, and it's easy to see why some people struggle to spend less than they earn. Create a budget, get some numbers down on paper and start to work through where your money is going every month, which leads me to my next point.

2. Pay yourself first. This premise can be found in a number of wealth creation books but assists in conquering most people's lack of ability to save. If you view your savings like a bill and one you must pay (which initially at least, will require some discipline), you will find the savings are essentially forced.

When you are paid, transfer money for rent, pay your phone bill, etc. and also pay your savings bill into a separate bank account. Learn to live off what is left and all of a sudden, your savings account will grow. The best part is that you almost certainly won't notice the difference (you'll have to trust me until you do it)!

A good rule of thumb is to save 10% of your gross income but a larger % will equate to quicker savings growth. In time it will become habitual, which, as already discussed, is a huge barrier broken when it comes to wealth creation.

3. Find alternate sources of income. When I was about eight years old, my Dad grew Roma tomatoes in the garden and there were so many of them, my brother and I decided to put them into bags and sell them to the neighbours. Years later in early high school, I discovered that by buying Push-Pops in bulk, I could sell them at a significant margin (at times 400%!) to the kids at school. In my early 20s after our plasma TV broke and it was too heavy to carry downstairs, I took a photo and put it on eBay for $1.00 in the hope that someone would come and pick it up and carry it downstairs for me. To my absolute disbelief it sold for $202.50 (and yes, they also carried it downstairs)! Needless to say, I started to spend some time looking for broken TVs on kerbs everywhere.

The point is that there is always money to be made if you think outside the box and get creative. Do you have a specific skill you can charge your time for? Is your garage (or your friends'/parents') a gold mine waiting to be listed on Gumtree? Ideally, your income will increase yearly in your chosen career, however the mistake most people make is raising their expenditure to meet it (see point 1).

Remember, we're talking about a specific saving goal, not a life time of scrounging, so any alternate source of money that you can implement does not necessarily have to be sustainable, it just has to accelerate your savings goal.

4. Consider using Lenders Mortgage Insurance. This is a touchy subject as it once again depends on not only your personal risk profile, but also the type of purchase. For home buyers, it is generally advisable to have a 20% deposit to avoid LMI as the cost of it is not tax deductible as it is for investors. However, you should also consider your savings rate versus the rate at which the market is rising. If you are saving say, $2,000 per month but the market is rising $5,000 per month on your target price range (as it was in Sydney in recent years), you may be better off using a smaller deposit and getting in earlier.

This strategy requires a significant number of considerations. The size of your mortgage will be larger meaning your monthly payment will be bigger, the Loan Value Ratio (LVR) of your property will be higher meaning you are geared to a higher level thereby increasing your risk, you have effectively 'paid more' for the property as the LMI is added onto your loan (known as the LMI being 'capitalised') and your interest rate risk is also higher given the increased size of your mortgage.

All these aspects should be considered and discussed with your financial adviser, QPIA and accountant prior to making a decision. Remembering though, that the reason you're using it is that if you don't, at some point most of those factors will come into effect anyway if the price of the property continues to climb, even if you manage to save the full 20% deposit.

5. Get rid of your credit cards. As with point 1, if you're spending more than you earn then by default, you are living on credit. When you spend $50 on dinner, you can now add the credit card interest payment onto that, meaning it could potentially cost you $60 over a year if you don't pay it off (assuming 20% interest which isn't unheard of), and how many dinners are you buying in a year? That $2,000 holiday? It's now $2,400 and you got absolutely nothing for your extra $400 payment. Remember, this is all after tax money too.

The worst part is that you have to pay it back at some point so delaying action is futile. If you have any savings at all, pay your credit card off and then get rid of it and start to implement point 2. Unfortunately most people's desire to "keep up with the Jones'" becomes their financial downfall as they spend money they literally don't have. 'Needing a credit card' to make in-store or online purchases is no longer a reason either as all modern debit cards can be used in exactly the same way, you're just using your own money instead.

Credit cards have their place once you have established financial discipline and can actually be a tool to save money (a completely separate topic) if used properly. However, it is impossible to save money if you are continually living on credit and unable to pay it off. Do the hard yards now and start to get ahead in your finances.

Next time, and as a continuation to this article, I will go a little deeper and discuss leveraging into property that you already own as a method of expanding a portfolio in a calculated and measured way.