Buying a House with No Mortgage

[Oynas]

Hi, I live with my parents at the moment. They told me that I could live with them for as long as I wanted. Because of this, I can wait before I buy a home. I am thinking of waiting, saving up, and then buying a house outright with no mortgage. Is this a good idea?

I like the idea of not having to be locked into paying interest for another 30 or so years. Plus I avoid home loan application fees, worries about fixed or variable interest rates, etc.

 

[Peter_Tersteeg]

It's a great idea if you've got the ability to do it. I'd love to own my portfolio (or even just my own home) debt free.

The problem is it's impractical for most people. If the house you want to buy costs $300k, it might take you 10 years to save that money. By that time the house might be worth $600k. It'll might take you 15 to 20 years to save the money to buy a house outright these days.

Borrowing money to invest is essentially leveraging. In a simple scenario, you put down a 10% deposit for a house. If the rental income covers the expenses (mortgage, rates, etc) it costs you nothing to hold. If the value of the property goes up by 5% over the next year, you've had a 50% return on your investment (ROI).

Cost to buy: $300k
Deposit: $30k
5% increase: $15k
ROI = $15k/30k = 50%.

If you had enough cash to buy the house outright, you could have bought (theoretically) 10 houses. 12 months later you'd be a lot wealthier having made $150k. The rent you receive on a single house might be $20k and the 5% increase ($15k) comes to a $45k return.

$45k return pales in comparison to a $150k ROI if you had of borrowed to buy 10 houses instead of owning one outright.

The reason I suggest it would be nice to own a house with no debt is becuase it's difficult to live of a ROI as opposed to living off rental income.

Disclaimer: The figures here are very simplistic and ignore many factors, costs and potentally market realities. They do however support the prinicpal.

 

[BoatBoy]

I like the idea of not having to be locked into paying interest for another 30 or so years.

So whats this, the stay at home until 50 plan?(assuming you are around 20 now)

Do you really think this is what your parents meant?

Dave

 

[Jebb]

I lived at home until I was about 27, granted 4 years of that I was living and working overseas...but after coming back home, I just couldn't live with my parents anymore!! Bought my own place...

It sounds good on paper, saving all that money, but itd drive me nuts...

 

[BayView]

Hi, I live with my parents at the moment. They told me that I could live with them for as long as I wanted. Because of this, I can wait before I buy a home. I am thinking of waiting, saving up, and then buying a house outright with no mortgage. Is this a good idea?

I like the idea of not having to be locked into paying interest for another 30 or so years. Plus I avoid home loan application fees, worries about fixed or variable interest rates, etc.

Nice theory, but unless you are on a $100k plus income per year, live like a scrooge and stay at home with the oldies, by the time you have saved enough to buy anything even half decent in the metropolitan area, it will have gone up by more than you have saved - most likely.

For example, say you decide to spend around $250k on a very basic 2 x 1 villa unit in Moorabbin, or a similar middle-ring Melbourne suburb. These properties are going to increase in value by around 7% per year - as an historical average. So, in year one, it will have gone up by around $17,500. In year 2, it will have gone up by around $18,725. In 2 years, it's value will be most likely around $285k - a $35k increase.

Most people wouldn't be able to save enough to cover the increase, let alone the rest of the purchase price.

Your best bet is to buy as soon as you have saved a decent deposit - 20% or so, and then use any spare cash from your income to smash the loan down as soon as possible.

This will save you many tens of thousands in interest over the term of the loan, increase your equity at a much accelerated rate and get you in a position to invest again much sooner.

 

[freddie]

.....Borrowing money to invest is essentially leveraging. In a simple scenario, you put down a 10% deposit for a house. If the rental income covers the expenses (mortgage, rates, etc) it costs you nothing to hold. If the value of the property goes up by 5% over the next year, you've had a 50% return on your investment (ROI).
Cost to buy: $300k
Deposit: $30k
5% increase: $15k
ROI = $15k/30k = 50%.

If you had enough cash to buy the house outright, you could have bought (theoretically) 10 houses. 12 months later you'd be a lot wealthier having made $150k. The rent you receive on a single house might be $20k and the 5% increase ($15k) comes to a $45k return.

$45k return pales in comparison to a $150k ROI if you had of borrowed to buy 10 houses instead of owning one outright.

The reason I suggest it would be nice to own a house with no debt is becuase it's difficult to live of a ROI as opposed to living off rental income.

Disclaimer: The figures here are very simplistic and ignore many factors, costs and potentally market realities. They do however support the prinicpal.

The first part of your disclaimer is true (the figures ignore many factors) but your figures certainly do NOT "support the principle" that you are espousing.

ROI is a much abused concept in which people choose what to include and what to exclude. The basic formula is ((value-cost)/cost)*100%. In the above calculation you have chosen to totally ignore the cost of the 90% of the money which is borrowed. Such an omission is of such importance as to completely nullify any message you may have attempted to portray in your example.

I suggest that such misleading presentations do no favours to the standing of your profession.

With regard to the original poster I suggest you buy a house outright if a house is what you want.

 

[Perp]

In the above calculation you have chosen to totally ignore the cost of the 90% of the money which is borrowed. Such an omission is of such importance as to completely nullify any message you may have attempted to portray in your example.

I think before you get on your high horse you might want to read a bit more carefully:

If the rental income covers the expenses (mortgage, rates, etc) it costs you nothing to hold.

I think that leverage is one of the most significant factors making property such an attractive investment, so from an investment perspective, I would never buy property unleveraged; I'd rent instead, and invest my savings elsewhere.

But if the plan is not about doing what's optimal from a $ perspective, but about lifestyle and peace of mind, then fill your boots.

 

[BayView]

ROI is a much abused concept in which people choose what to include and what to exclude. The basic formula is ((value-cost)/cost)*100%. In the above calculation you have chosen to totally ignore the cost of the 90% of the money which is borrowed. Such an omission is of such importance as to completely nullify any message you may have attempted to portray in your example.

This is true; the figures can be distorted.

To me, ROI means simply this; how much money have I personally contributed to the deal, compared to the nett return after tax I receive.

This, to me, is the only real way of comparing the return to what you would get if you stuck a lump of cash in a Bank account, and paid tax on the interest received.

In the case of Property Investing, if I use only equity from other property as my contribution to the deal, I have contributed no actual cash into the deal.

If the nett return after tax is positive, including the cap gain (which hasn't been realised as I haven't sold), then the return is infinity in this case.

This rarely happens where you physically don't put any money in though; most property investors need to inject some cash to cover rent shortfalls and other costs.

But say, for example, you put in $10k of your own funds to cover shortfall, and your tax return netted you a $1k positive cashflow, and your property went up $30k in value.

Your contribution is $10k, so your cash-on-cash return is 10%, but you ROI is 32.25% on the money you contribute.

 

[freddie]

I think before you get on your high horse you might want to read a bit more carefully:

The rental return is entirely irrelevant to Onyas's question. He's living with his parents presumably at very low cost. Onyas was asking about the timing of purchasing a PPOR. The message in the response from PT Bear appears to be - don't buy one PPOR - buy 10 PIs.

 

[sue78]

If that's the type of risk you are comfortable with then go for it. Look, everyone have different plans to reach ultimately the same goal.

Some buy 10 ips, some save and pay off PPOR and this way it's actually way less riskier and then you have plenty of equity to be buy IPs and be picky about it.

Buying Ips is not all that great...there's a lot of stress involved too and for ppl that keep saying the earlier you buy the better, whilst that is true...I can assure you that it's never too late to enter the property game.You should do it when you are in a position to do so and comfortable with the risks involved.

I actually think in this current economic crisis, the people in the best position are the ones with no debt...nothing to worry about.

As a matter of fact, if you think about it...it's really not that hard to pay off your ppor. A newly wed earning $80k each, choose to stay at home or say live abroad...if they save 75% of combined income then they can own their PPOR outright in 3 or 4 years.

Asians do this a lot. You have 3 or 4 familles living at home. They buy a huge house and all the famillies (so like 3 or 4 working couples) pay off the mortgage quickly within 1 to 2 yrs. Then they do it again until everyone has their own house. Butasians generally love big famillies. I love it too...grand parents help raise kids, everyone chips in for maid helper, all the nieces an dnephews live in one house and grow up together...it's brillliant.

A lot of ppl here love debt but look at what debt has done? even the biggest companies have fallen. If you have a situtaion where the bank has turned itsback on you and no onewants to buy your house and you run out of cashflow then goodluck and we see this happenening a lot atm.

 

[willair]

Hi, I live with my parents at the moment. They told me that I could live with them for as long as I wanted. Because of this, I can wait before I buy a home. I am thinking of waiting, saving up, and then buying a house outright with no mortgage. Is this a good idea?

I like the idea of not having to be locked into paying interest for another 30 or so years. Plus I avoid home loan application fees, worries about fixed or variable interest rates, etc.

Depends on what you want in life and how quickly you can make make your money grow,if not property what will you do with the money banks don't pay much after the "ato"takes their slice,the ASX is still very high risk,that's what i would be looking at with money you save where do you invest it?this is not advice....willair..imho..

 

[GoAnna!]

Hi, I live with my parents at the moment. They told me that I could live with them for as long as I wanted. Because of this, I can wait before I buy a home. I am thinking of waiting, saving up, and then buying a house outright with no mortgage. Is this a good idea?

I like the idea of not having to be locked into paying interest for another 30 or so years. Plus I avoid home loan application fees, worries about fixed or variable interest rates, etc.

Living at home would certainly give you a flying start as you are able to save for a deposit far more quickly then if you were paying rent etc. I agree with Pete that buying a place outright is another thing altogether. Saving more quickly than houses rise in values would be a challenge to say the least unless you are on a sizable income or or if you invested in another asset class such as shares so that your savings were growing rather than being "eaten" by inflation.

In the scenario you have outlined there is no reason why you would need to take 30 years to pay it off. Have you done some calculations to see if you bought with say 20% deposit and paid additional repayments how quickly you would pay it off? You might be pleasantly surprised.

If you were comfortable to let it out you would be able to negatively gear any shortfall (assuming there was a shortfall) therefore taking some pressure off the holding costs.

Or you could buy when your rent covered the repayments and fix some of the loan at low rates if certainly was important to you. You could then focus oin paying down the variable portion.

Can I ask why you want you own home and when you hope to purchase it? What exactly worries you about debt? Are you currently good at saving? Do you have the self disipline to maintain a high level of savings over a long period of time?

 

[Peter_Tersteeg]

The rental return is entirely irrelevant to Onyas's question. He's living with his parents presumably at very low cost. Onyas was asking about the timing of purchasing a PPOR. The message in the response from PT Bear appears to be - don't buy one PPOR - buy 10 PIs.

Actually I thought the message I was trying to send was that there's more than one solution. Buying a PPOR outright is fine, I've got no problem with that at all and may people are happy with that. I'm fairly sure my original post stated that.

What I was also trying to demonstate was what the power of leveraging and using other peoples money can do to accelerate wealth creation. I'll grant that the example is light on figures, but the comment on rental return is a highlys relevant part of the equsion and one of the core strengths of property investment, as it is what allows investors to hold property and thus leverage so highly. Given what I do for a living, I can assure you I have a very detailed understanding on the importance of rental income.

I appologise that my post was light on detail. Unfortunately I'm not as skilled an author as some and don't express many of my ideas as clearly as I'd like to.

 

[Perp]

The rental return is entirely irrelevant to Onyas's question. He's living with his parents presumably at very low cost. Onyas was asking about the timing of purchasing a PPOR. The message in the response from PT Bear appears to be - don't buy one PPOR - buy 10 PIs.

PT Bear's point was - as I'm sure you appreciate - that property really works as an investment when leveraged, rather than unleveraged, and I believe this was the focus of Onyas' question (ie financially focused), rather than about timing the market. If Onyas leveraged, the rental return would be relevant for the nine properties that he (presumably) wouldn't be living in. As many people are motivated to buy a property - even their PPOR - because they consider it a good investment, then I feel that PT_Bear's response was entirely appropriate.

Onyas, GoAnna makes a great point about a strategy which combines the best of both worlds: buy as soon as you have a deposit, then pay off what you were saving - presumably you were looking at saving $30K a year or more - onto the loan. You'd have that loan paid off quite soon, and the interest would certainly be smaller than the increase in prices.

Let's assume the following:

* mortgage interest 7%
* capital growth 7%
* cash savings earns 4%
* contributions from income (to savings or repayments): $30K per year
* we're now 1 year into a 10-year plan, ie $30K in the bank already

Scenario 1: Buy now

Use the $30K you have in the bank as a 10% deposit on a $300K property. You make payments of $30K per year. It will take you just under 15 years to pay off the loan.

Scenario 2: Save and buy later

You save your $30K each year, earning 4% pa. You wait an eternity - the 15 years it would have taken to pay off the loan, to make the comparison easy . At that time, you have $585K in the bank. Congratulations - it sounds great, doesn't it?

But discount it for the 7% capital growth, and that property would sell today for $216K.

So by buying now and making mortgage payments, you can buy a much nicer property than you could if you saved for it! Today you can have the $300K house for exactly the same money as having the $216K house in 15 years' time!

Which do you want: the $216K property, or the $300K property? And do you want it in 15 years' time, or now?

 

[kum yin lau]

Hi, even if it was only to buy PPOR, not borrowing is against all known factors.

Borrowing locks you into a commitment.

And that's the crux of the issue, isn't it?

Freddie, unless you own property, your opinions are very dangerous to anyone asking for advice.

At the end of the day, if you have the choice, whose advice would you take? Those who have done it or those who haven't?

Those not wanting to commit to any payment would be best advised to live in their parents' home until they pass on and then the house would be theirs, period.

KY

 

[GoAnna!]

I think people can exaggerate the commitment a mortgage is. A property can be sold. Of course the main risk is selling for enough to cover your loan plus selling costs.

To reduce this risk:

Purchase a well located attractive market priced property
Put in a sizable cash deposit
Make extra repayments
Make improvements.

The other way of reducing the risk is to start small. This may not be relevant if you have your heart set on a particular type of PPOR but if the alternative is being too scared of buying anything it would be a god start.

As the saying goes "Get on the train, you can always change carriages"

 

[Oynas]

For example, say you decide to spend around $250k on a very basic 2 x 1 villa unit in Moorabbin, or a similar middle-ring Melbourne suburb. These properties are going to increase in value by around 7% per year - as an historical average. So, in year one, it will have gone up by around $17,500. In year 2, it will have gone up by around $18,725. In 2 years, it's value will be most likely around $285k - a $35k increase.

Most people wouldn't be able to save enough to cover the increase, let alone the rest of the purchase price.

Maybe I won't save purely in cash. Maybe I can put my savings into a real estate mutual fund. Then when I enough to buy a house, I'll withdraw it all out and buy the house outright.

I think that leverage is one of the most significant factors making property such an attractive investment, so from an investment perspective, I would never buy property unleveraged; I'd rent instead, and invest my savings elsewhere.

So if I have, say, $300,000 in a mutual fund then I should use the passive income from this money to rent? Suppose I can get passive income of 5 per cent, so $300,000 in my mutual fund will generate $15,000 per year or $288 per week, which I think is enough to rent a nice house!

Is it better to use the passive income from the $300,000 in my mutual fund to rent a house or do you think I should just buy a $300,000 house outright? Which is cheaper? Which is better?

Can I ask why you want you own home and when you hope to purchase it?

My parents say I can stay with them for as long as I like, but just in case they decide to throw me out I will want a home to fall back on because I don't want to live on the streets.

When do I want to purchase it? As soon as possible, but not too early otherwise I will have to pay interest.

What exactly worries you about debt?

Debt we can define as a future obligation. Since it is an obligation, it coerces us to do something, something we may not want. For example, currently I work part-time because this year I was a university student. At work, many workers complain that they hate the company, the job, etc but are reluctant to talk against management or to quit because they had mortgages to pay off. The obligation to pay the mortgage forces them to suck up to the boss. It reduces their power, reduces their freedom.

Are you currently good at saving?

At the moment I save more than 80 per cent of my income. I give a little to my parents and to charity. All up I've saved about $25,000 so far. I hate shopping at malls but I like shopping online.

 

[JIT]

If you're just starting off in the wealth building/accumulation game I think you'd be financially better off in the long-term by buying a few IP's initially at maximum serviceable LVR's, and when interest rates bottom out, lock them in for 5+ years, making your IP portfolio close to neutrally geared.

Then stop buying IP's as you could get burnt holding a lot of expensive debt as variable and fixed interest rates start to rise again, and quite possibly over and above rental increases (with the exception to stopping being if your JOB/business income/serviceability level is still high and expected to rise significantly in the coming years).

And instead, at this time, now buy your first modest PPOR and with modest borrowings (relative to your income/serviceability level), but with a small cash deposit and on a variable interest only rate loan, and start paying it down into a 100% offset account, add value to the property whilst you're living there, and let leverage and compounding growth do its trick.

At the end of the next growth cycle you'll be close to having a debt free/low LVR PPOR that's gone up in value a few hundred K, and which you can now (if you want to) sell CGT free and upgrade to an even bigger, "dream PPOR"...(+/- some more modest borrowings relative to your income/serviceability level).

You'll also have those IP's in the background ticking away and increasing your real net worth...and if the cycle has come full circle again you can now use the increased equity in these IP's as deposits on more IP's when interest rates are low again, which you can again fix for 5+ years, and make the portfolio close to neutrally geared once again.

You keep doing this until you've accumulated "enough".

It's a time in the market + timing the market +/- value adding along the way strategy.

(And purely based on using residential property as a highly leverageable growth asset class.)

A very simple process really, but a bit hard to figure out when to stop!

You then need to modify your strategy to generate a higher passive income.

This is not so simple though!

It does all depend on where we are in the interest rate/property cycle when you first start investing, and how much cash savings/equity you have to begin with, as well as your JOB/business income and the growth you get on your first few IP's...

Here's some old threads that might be relevant :

http://www.somersoft.com/forums/showthread.php?t=38260

http://www.somersoft.com/forums/showthread.php?t=38186

 

[dave99]

At work, many workers complain that they hate the company, the job, etc but are reluctant to talk against management or to quit because they had mortgages to pay off. The obligation to pay the mortgage forces them to suck up to the boss. It reduces their power, reduces their freedom.

Oynas, if workers aren't sucking up to pay their mortgages, they're sucking up to pay their rent. When you sign a 12 month lease, that really a bigger commitment than paying a mortgage on a house you can sell anytime.

Of course, you live at home, so you don't have to pay rent or a mortgage. Nice for you. But it's not really fair on your parents, after having spent so much on you over the years, to have to continue to subsidise you into their old age. You should move out, pay your own way and let them enjoy their empty nest!

 

[sue78]

but not all parents are like that, especially if the other half has passed. I'd be so depressed when my kids move out and I would want them to know there's always a place for them at home. I just prefer it when there's more people in the house and I don't even mind if my son stays at home after he's married, and even better if we have grand kids.

Obviously, he's expected to cook for himself occasionally, clean his own clothes etc and contribute towards household bills. He can't live at home yet not bettering himself....if he's working hard and saving hard thenhow can I not support that as a parent? andif he was really honest, and I had the money I would even help him out.

but I doubt he will coz we already decided that all our kids will be going abroad to UK to do their degrees andlive in dorms. My husband wants them to experience what he went through. So lucky...I hate it how we don't get to go away for Uni in Oz.