Do you really need to save 20 per cent for a home loan deposit? Should you be looking to save 10 per cent of your income as a rule of thumb? Why not pay off your mortgage as quickly as you can?
Classic financial advice never goes out of style. However, it’s called classic on the tin for a reason. That advice has been around a fair while.
The More Things Change
Lifestyles, economic factors, technology, even the nature of work itself have all evolved significantly over the past two decades. Shouldn’t we be periodically revisiting the way we manage our personal finance.
- Save 10 Per Cent Of Your Income
This is an oldie but a goodie or at least it was. Tragically saving 10 per cent of your income is unlikely to get you to a comfortable retirement these days. Although it is certainly better than nothing it is no longer the benchmark for guaranteeing retirement success.
Two factors impacting our requirement for retirement savings is the escalating cost of healthcare and a longer life expectancy.
Rather than focus exclusively on savings rates during our working years, many prospective retirees would benefit from switching their focus to managing their expenses more effectively while still maintaining a decent quality of life.
Far too often, it is the expense load particularly debt than eats into our ability to provide for our own retirement.
2. All Credit Card Debt Is Bad
In the golden years of financial planning, credit cards were seen as inherently evil and a source of unnecessary indebtedness. Credit cards parents would tell their children are for emergencies only.
How times have changed!
Today, credit cards feature a range of diverse benefits as well as effective tools allowing you to track your monthly spending, bolster security and theft protection and depending on the car, potentially reap cash-back rewards and free insurance.
Today, it often, it makes more financial sense to channel your spending to your credit card over using cash.
However, that doesn’t mean swiping your plastic with wild abandon. Ensure you put in place an automated monthly payment from your savings or checking account to pay off your monthly credit card balance in full. This strategy gives you all the convenience of plastic without the downside of incurring any painful interest charges.
3. You Have To Save 20 Per Cent For A Home Loan Deposit
If you’ve ever thought about joining the ranks of homeowners by purchasing your own home, you’ve probably encountered the old adage of never taking out a mortgage until you’ve saved up at least 20 per cent for a deposit.
The perceived problem with not being in a position to make a 20 per cent deposit is being forced by your lender to take out private mortgage insurance. Private mortgage insurance is notoriously expensive and is only of value to your lender.
Higher mortgage payments can be painful, but the financial trade-off between being able to buy as opposed to having to wait years while you save up enough for the deposit could be worth it.
This is particularly the case in a time when interest rates are low.
From a financial perspective, if you assess the macroeconomic factors dominating our economy over the past decade real estate has appreciated significantly in most capital cities while wage levels have effectively stagnated.
Despite occasional pricing wobbles, property remains a viable long-term investment, while flat wages growth is making it increasingly it unrealistic for many would-be homeowners to save up a 20 per cent deposit within a reasonable time frame.
Increasingly, financial advisers are advocating a new rule of thumb. If you can save a 20 per cent deposit for your home within five years, go for it. However, if you are going to need more time to accumulate your deposit you are going to be doomed to forever chase a fast-moving target as home prices escalate.
Not only will you delay being able to move into your own home, you will also miss out on the opportunity to enjoy any capital gains appreciation you may have had on your own home, had you bought into the market
4. Pay Off Your Mortgage As Soon As Possible
For many people, their mortgage is the largest debt they will ever take on. So if the opportunity arises to retire that debt burden early, shouldn’t you leap at the chance?
In times of high prevailing interest rates, when those interest rates typically hovered in double-digits while investment returns were on average only around eight per cent, that advice was financially sensible.
Today, however, the majority of homeowners still have an effective mortgage rate well south of five per cent. By comparison, savvy investors can still expect to earn eight per cent or more annually on their investments.
In this situation, it makes more sense to focus on building up a good credit record by making your mortgage payments on time and directing any free cash you have at the end of each month into higher yielding investment. In this context, it makes sense to prioritise your investments over paying down your mortgage.
It’s about identifying the best potential return on your investment dollar.
5. Renting Is Just Throwing Money Away
Australia has had a long love affair with home ownership. At one point we had the highest homeownership rate in the OECD. So, when you are in the position of having to pay rent to a landlord for years with nothing to show for it at the end, you may feel like wasted an opportunity to achieve an important financial goal.
However, in many instances renting provides you with a life free from major expenses such as mortgage interest, mortgage insurance, land taxes and maintenance costs amongst many other costs.
Plus, in some situations, renting opens up opportunities to earn more money by investing in non-property sectors.
From this perspective, renting frees you from placing most of your assets into one single, expensive and illiquid investment. It gives you the freedom to accept a lucrative job offer in another state.
In the current economy, there is significant monetary value to being agile in terms of your living arrangements. Moreover, in times of a declining or low growth property market or high interest rates environments, it may be financially preferable to rent.
Naturally, renting isn’t true for everyone. The actual financial benefit of renting versus owning your own home as a financial strategy depends on your profession, location, investment opportunities, lending climate and interest rates.
In general, young adults shouldn’t always believe buying a house is the default, gold star option.
Investment strategies and money, in general, is always deeply personal. What was true for one generation may no longer hold true in today’s more complex economic and financial climate. So when it comes to deciding on your investment strategy and managing your finances, you should always take any one-size-fits-all rule of thumb with a healthy grain of salt. There’s always an exception to the rule and you could just be that exception.