Financial Advisors are constantly asked “what do I need to consider when buying a home?” Here are my guidelines (relating to your primary residence) to assist you in avoiding long term mistakes.
• It is easy to buy but hard to sell.
Many individuals are very excited, especially with their first property purchase, in which case emotions dominate logic. It is important to step back and to try and apply a structured thought process to your desired purchase. I always strongly recommend making a list of the relevant pros (being is a secured area) and cons (large amount of future maintenance or landscaping required) of your property purchase, always keep in mind future planning such as having a family or work travelling. “I really love and need this property” does not count as a pro, unfortunately.
• Buy the “worst” house in the “best” area.
One of the key considerations for property is “area, area, area!”; it is very difficuly to try and determine whether your house value will appreciate or not (chances are your predication will be wrong anyways), so this is something best left to residential property experts. A way of simplifying your decision making, is always aim to buy in a good, well established area , however take your time in buying at a good price! It does not help over-paying just to be in a desired area. Your estate agent can provide great insight and is worthwhile paying for an estate agent with experience and knowledge.
• Deposit needed.
I always advise my clients to never fully finance their residential property – see rule number 4 – it is a prudent approach to always place a minimum of 10% of the purchase price of your property as a deposit – this saves on large amounts of interest over the term of your bond. I also recommend accumulating another 10% of the purchase value of your property for additional costs such as conveyancing fees, transfer duty and any changes you would like to make to the property, such as, automated garage doors or painting your new property. Any remaining funds can be placed into your bond to further eliminate debt (please also see rule 7 in conjunction with this).
• If you have to finance the property over more than 20 years you can’t afford it.
What I refer to here is the monthly payment needed to settle your bond in 20 years, many individuals (especially self-employed entrepreneurs whom are concerned by their earnings fluctuating) do opt to take their bond over 30 years as the mandatory payment is lower. Of importance, however, is that they actually practice the discipline of increasing their monthly bond re-payments to settle the bond over 20 years. The 30 year repayment term should only be done as a precaution against cash flow constraints. Your financial planner can easily help you with this calculation.
• Negotiate your interest rate.
Many people express absolute loyalty to their current bank without considering how much a lower interest rate can save them, it will always pay you to shop around for the best deal on the finance for your home bond and, considering the services of a bond originator is recommended. For example, buying a R1 000 000 property and paying it off over 20 years at a 10% interest rate will cost you R1 316 054 in interest alone! This is a large leakage of wealth that could have long term negative effects. Simply negotiating an interest rate of 9% would save you R156 709 in interest savings – it is worth the exercise!
• Do not under-estimate having an emergancy fund.
An emergancy fund is a key component of any good financial plan (this article will not expand on this idea though). Unforeseen expenses will always occur and can affect cash flow to a great extent (just think of how much a geyser or repair of your roof could cost). It may be a wise approach to “park” your emergancy funds into your bond but only do so if you are able to access the funds immediately – see Rule 7 below. A general rule for the minimum amount of emergancy savings would be 3 to 4 four months’ worth of your net personal expenses, this will be different if you are a business owner or entrepreneur.
• Access Bond.
This is an important component of cash management over the life span of your bond; if you are going to pay a lot of extra money to your bond every month to pay off your bond quicker, you may consider “parking” your emergency funds in your bond. This means it is important that you always have immediate access to your money as its purpose is to cater for emergancy events. An access bond is one where any additional funds you place into your bond, over and above the minimum contractual payments, can be accessed immediately without approval from the bank. This is a good idea if your bonds interest is hypothetically 9% while your money market account is giving you 4%. Many banks also allow you to control this by having internet banking for all products held with them.
• Insurance should always be considered.
It is an absolute “golden rule” when I dispense advice that if you cannot afford to pay for what you have borrowed in cash then you should not have borrowed it to begin with; the same goes for insurance on your home. Any damages that occur to your property can run into tens of thousands of Rands, it is essential that you protect yourself from this cash flow risk by having insurance. Chances are your bank will also not give you the loan without having the appropriate insurance in place. Not to mention, insurance may provide for much needed liquidity in your Estate should you pass away.
The above rules are a non-exhaustive list; I recommend that you always sit down with your FPi registered Financial Planning before making any financial decisions.