Monday, 14 July 2014

How to save for your home deposit

Have you thought about buying your own home?  Have you done all your maths and worked out that actually...yes you can afford a home and it is the right time for to buy your first house?  Many people get to this situation and then realise that they are missing one big hurdle...they don't have the deposit they need for a house.

This post will give you some practical tips about how to save your deposit and my views on how much you should save for your deposit.

Saving a deposit for your first home is hard...

I actually think saving a deposit for your first home is one of the hardest savings and investing things that you will ever have to do.  There are so many behavioural and practical factors working against you including:
  • It is incredibly hard to be disciplined and not the spend the money on other expenses that come up.  Unexpected expenses almost always arise and when you have a pot of cash sitting there it is incredibly easy to dip into this pot of cash
  • The goal seems so far away.  Saving for a deposit is rarely something that you can do in a few months.  It takes serious effort over a few years and it is easy to get disenchanted
  • You actually need more than you think...I will cover this below but unfortunately due to transaction costs (such as stamp duty and other costs associated with buying a property) you need more money than just the x% of the property value that you were aiming for

I am currently saving for my first place of residence.  If you follow this blog you will know that I already have an investment property however I have 'ring fenced' my investments (not legally but rather as a personal rule) so I am effectively saving for my first investment property all over again.  

Here is a plan to make saving a deposit for your first home easier...

The 5 step plan below is one that I am using to save for my first home.  It helps focus your savings efforts and will hopefully provide a path for you to buy your first home.

1. Work out how much you want to spend on your home

In order to do this you need to sit down and think about your future plans.  Questions to ask yourself may include
  • How long do you want to take to pay off your loan? 
  • Are you doing this on your own or with your partner?
  • Is your financial situation going to change (e.g. are you planning on having children?)
  • Is this a stepping stone or do you want to live here for a significant period of time?
  • Could you afford to still pay for the property if you had to take a pay cut?
Obviously there are heaps of other questions you need to ask yourself...but what you are essentially trying to work out is 'how much can I borrow and still be comfortable given where I see myself (realistically) in the medium term?'

2. Work out how much you want to have as a deposit

I recommend saving at least 25% of the value you identified above.   You need at least 20% (in Australia) to avoid paying Lender's Mortgage Insurance (LMI) which is an amount you pay to insure the bank (not you) if you default on your loan.  This amount is a pure expense and can be avoided if you have an LVR of 80% or less.

The other 5% is to cover your transaction costs that invariable arise.  Things like stamp duty, lawyers fees, bank fees and other charges all cost money when you are first buying a house.  The chances are that you will also need to do a bit of work on the house and kit it out with some stuff so having that extra buffer is really handy.

3. Set yourself a time line to buy your first home

Time lines are great because they focus the mind.  Even if the time line is reasonably long I think you should still set it and work towards it every single day.  My time line for buying my first house is 3 years.  I could probably do it sooner if I tried but I have plenty of other expenses coming up in the near term.

4. Work out your savings plan...and stick to it

Everyone will have a different savings plan.  It will be different if you have a partner or if you are single, if you are a high wage earner or if you tend not to have a lot of spare cash at the end of the month.  Your savings plan can be as brutal or as easy as you like.  If you want to reach your goal faster you will obviously have to sacrifice more and it all depends on your own tolerances.

If you are saving as a couple and both people in the couple have jobs the best way to save for your first home is to live off one persons wage and save the other persons wage.  The best part about saving the whole wage of one person is that you can put it straight into a savings account every month and not even see it (or touch it and be tempted to spend it).

If you are saving on a single income or as a single person then work out how much you can save each pay check.  Make it a dollar amount and this amount goes into your savings rain, hail or shine.  I don't care how tempting that next holiday doesn't get taken out of your savings.

5. Put your savings into an account which you will not withdraw from

A lot of people tend to deposit their whole wage into their savings account and then withdraw it as they need it.  I understand the rationale for this but I think it's silly.  If you are used to withdrawing cash from your savings account you will not think anything of dipping in here and there for various expenses.

Set up a separate savings account or use one which you do not withdraw from.  I use my investment property offset account.  Once money goes into that account it is like a vault and it is only in incredibly rare situations that I withdraw from this account...and even then I deposit it back within days.

Here is my plan...

I know that a lot of this sounds great in the abstract but perhaps you want an example?  Well here is my plan.  My girlfriend and I have talked about buying a house together and this is the plan we have tentatively been talking about:
  1. Given our life goals we think we can spend ~$650,000 on a house at that point
  2. We want to have ~$350,000 saved up by that point.  That is far more than my suggested 25% but this is because I am already levered in my investment property.  On the flip side I already have ~$100,000 in this account so my real aim from now is to save another $250,000
  3. Our time line is approximately 3 years from now
  4. Our savings plan is for us to live off her wage (significantly lower than mine) and save most of my wage towards the house which will get us over the line in ~3 years time (accounting for my large expenditures next year)
  5. As mentioned above I plan on using my Investment Property offset account because it is the highest effective return that I can get
Although it is incredibly simple there is a lot of work that goes into all of those steps and questions.  However once the plan is set it is incredibly easy and process driven from that point.  All you need to do is stop yourself from being tempted to use that money for some other purpose.

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  1. Wow! Saving $250,000 in 3 years is a massive target! It does sound achievable though, as long as you stick to your plan.

    I'm guessing you're not going to think about selling the investment property to fund the purchase so you can reduce your non-deductible debt straight away?

    1. I actually think it will be harder than I first imagined. I tried to estimate actual living costs with my girlfriend and we realised that we spend far more (on a combined basis) than just her income. We are trying to work out ways to get it down to that level though.

      I don't really need to sell my Investment Property. I have not been paying down any of the principal on that loan but rather have been putting the cash in an offset account. I will use the cash in the offset account to pay down the PPOR loan which will effectively regear the tax deductible investment property loan.