Purchasing a property is an exciting time but also a big decision. Whether it be your own home or an investment, it is something that most people only do a few times in their lifetime. Before you take the plunge, it is paramount that you weigh up both the benefits and the risks involved. In most cases, the opportunities that a property purchase offers outweigh the risks. Benefits include:
- Potential to grow wealth
- Secure your retirement
- Diversify your investment portfolio
- Provide a place to live and a lifestyle
- Negative gearing tax benefits
- Provide financial security
The risks however, can be harder to judge. Overstretching yourself financially can place a huge burden on your lifestyle and your family.
Having worked as a property valuer for over eight years, I have seen more than my fair share of financial distress and mortgagee in possession sales.
Underestimating the risks associated with a property purchase can lead to these devastating situations. This is not a position anyone wants to find themselves in.
To avoid financial distress when purchasing a property it is critical you STRESS TEST your financial position and your investment.
THE STRESS TEST
Rising Interest Rates
Consider if you could still afford the property if interest rates were to go up 0.5% or even 1%. For example, on a 30 year, $400,000 loan the difference in repayments from 6% interest to 7% interest is about $77 p/w (interest only repayment structure).
It would be neglectful not to take out building and landlord protection insurance policies. This will protect you against financial loss if your building is damaged or destroyed by unforeseen circumstances such as fire. While, landlord protection will safeguard you against the tenants damaging the property. But you need to be sure you can afford this type of protection.
Job Loss or Injury
How long can you meet your mortgage repayments if you lose your job? You can get income protection insurance in case of injury, but you can not insure against job loss or redundancy.
Some experts suggest that all property owners should have 3 months mortgage repayments available to them in case of job loss. This may not be in the form of cash savings, but consider things like redraw facilities on existing loans, family loans, shares or additional assets that could be sold quickly in a time of need such as a second car, boat or motorbike.
Ask yourself, ‘can I still afford the property if it is vacant for 1 month’. A prudent investor should have at least 1 months mortgage repayments available to meet the monthly loan commitment without a tenant.
Major Maintenance Project
When purchasing a property you need to consider if there are any major maintenance projects required in the next 3-5 years. Whilst there is always the potential for unforeseen repairs and costs with any property, doing a thorough maintenance and repairs assessment of the property prior to purchase could be a valuable budgeting tool. If you do not have the expertise to do this yourself, you can request your building inspector do this for you when they undertake the pest and building report for the purchase.
The Ten Year Plan
Whilst some properties will increase in value in the first 5 years of ownership, this will depend on market conditions and the timing of your purchase. Property is considered to be a 10 year investment as the ‘typical’ market cycle is roughly 10 years. So when you purchase a property you need to ask yourself, ‘Am I prepared to hold the property for up to 10 years’. This is the best way to safeguard yourself against a loss from selling too early in the market cycle.