Some practical tips on saving for a home loan deposit

In a recent newsletter we explained how saving money for a deposit can make a huge difference to your finances over time compared with renting. Some people view rent as 'money down the drain' whereas mortgage payments go towards something tangible - your own home. That's not quite right. In each case there is a payment for the rental of the asset - in the case of the rent it's the house in the case of the mortgage it's the money. So far so good. 

But owning a house generates a number of advantages. Firstly you capture for yourself - rather than your landlord - the rising value of the house. House prices have been rising strongly for some time, which means they probably won't rise as fast in the next few years. But even if they rise at 1 or 2 percent per annum, over time that generates huge benefits. Secondly unlike virtually any other investment, capital gains on your house are tax free. 

We know saving is not always easy, so in this newsletter we offer you some tips. We'll give you some ideas on how to save smartly, let you know what lenders look for in your savings history, and review the best places to put your money to get it to pile up into a deposit.

You may have seen advertisements for low deposit loans. When lenders lend above 80% of the value of your home they almost invariably purchase 'lenders' mortgage insurance' - which they then require you to pay. This insures them (not you!) in the case of your falling into difficulties and default. Mortgage insurers are a pretty inflexible lot. Most won't provide insurance above 95% of the value of the property. Some insure loans of up to 97% or even 100% of the property. 

But in each case it's hard to get approval if you cannot demonstrate some savings - usually you have to have saved 5% of the value of the property - though there are some exceptions. And the most competitive loans are usually unavailable at LVRs of over 95% - and sometimes 90%. 

Also, if you've made the decision to save for a deposit, it's very important how you do so. Oddly, banks will often fail to accept the repayment of an existing debt as savings - though that's what an economist would call savings and it sure feels the same! Savings in non-market assets are no good either. This goes for savings under the bed, savings invested in cars or consumer goods. Lenders see that as spending, not saving. Even if you could sell that vintage bottle of wine for more than you bought it!

Now, how can you maximise the amount you save?Reduce the amount of credit cards you use. Credit cards can easily distract you from a savings plan. 

Failing getting rid of the dreaded card, pay your card off before the interest free period ends. Let the banks lend you money for nothing - which they do for up to 55 days. Interest rate charges accumulate quickly. By the same token, so long as you're paying it off each month, put as much as you can on the credit card to qualify for loyalty points that can save you money. (Don't do this if it makes you spend more easily).

Find something to give up! If you smoke cut down or give up. If you go out twice a week, go out once a week. Plan to save small amounts of money on a regular basis. Draw up a budget setting out your income and expenses. We've attached an example below. You can either print out the table below, or download a preprogramed excel spreadsheet from our website at www.peachhomeloans.com.au/resources/budgetplanner.xls

Overall no matter what bank account you choose or whether or not you decide to invest in higher returning assets it is essential that you devise a good savings plan and stick to it. This will make saving a lot easier and faster. You'll have your deposit with a lot less stress. Then you can usually relax a bit knowing that the mortgage payments will impose a savings discipline on you even if you don't build up a lot more money in the bank, or the home loan. 

Small amounts of regular savings can lead to an impressive total over time and will demonstrate your consistent saving to a lender.

You also need to find the right vehicle in which to put your savings. Generally the banks will tell you that you need to choose between transaction accounts - with low interest but low transaction fees and savings accounts with higher interest but higher transaction fees. Indeed a number of financial journalists say the same thing. 

But there are some tricks. If you're prepared to use B-Pay and other internet based technologies for payments, you can get accounts with low or zero fees but high interest rates. (Also, if you don't have a cheque book you can avoid banking taxes.) Check the terms for yourself, but an excellent product, which we use at Peach is offered through the Adelaide Bank by Australian Unity. 

Access to your money is always a bonus if you are house hunting. However, if you are likely to be tempted to spend the money you've saved, you might want to tie it up. Various savings accounts provide penalties for early withdrawal as do term deposits. 

Another option, which is routinely ignored for the purposes of saving for a deposit is share investment. Share investment generates higher returns on average than most other normal investments, but it also is more volatile and comes with higher costs of establishment - brokerage etc. This means that you can lose some of your capital if you are unwise or unlucky.

So the share option is not for everyone. But if you are young and you don't mind if things go against you, or waiting a little to buy your house as your shares recover then you might like to pile your savings into a unit trust. If the fund goes well, you save more money. The upside is that in most occasions this will help you achieve your deposit sooner, so long as you understand that if you're unlucky it could take longer!

Also, especially if it is relatively short term, make sure you use a discount investment broker who will not charge you for entering the investment. Contact us and we can put you in touch with one who not only rebates most or all upfront fees, but also rebates some trailing commission. You usually need a thousand, or often several thousand, dollars to enter either a managed investment via a unit trust or a term deposit. 

If you are interested in putting money into a unit trust, we can help you contact a discount investment adviser. You will not just receive a rebate on your up-front fee that is available now through a range of advisers but you will also receive o a rebate on some of your trailing commission. Drop me an e-mail at ngruen AT peaches DOT com DOT au and I'll  shoot you their details.

In some ways the important thing is not what you invest in - though investing in your own home is tax advantaged and a very good asset to own yourself. Whilst we live in a capitalist economy, it's important to get some of that capital and get it working for you - rather than hiring it from others. That means the sooner you get into the savings habit, the sooner you'll get on top of things financially.

Cheers


AKA Nicholas Gruen  
April 2002

Please note: The observations made here are general and indicative.Nicholas Gruen is not a qualified investment adviser. Further his comments are general and do not take into account your specific circumstances. Nor are they warranted as free from error in any respect whatsoever. You should not rely on any aspect of them without taking independent financial advice relating to your own specific circumstances. We suggest you obtain advice on a fee for service basis rather than from someone who earns either up-front or trailing commissions from investments they recommend. We would be happy to let you know of service providers who provide advice on this basis.