A comparison of the various ways to buy a home.
There are many different ways to buy a home – which is why we decided to compare some common strategies below.
1) Buy a property with a 20% deposit.
This is one of the most basic ways to buy a home is, it’s the cookie cutter approach to home ownership. A buyer puts down a 20% deposit and gets an 80% lend to settle the property. On top of the deposit, the buyer has to fork out for stamp duty and legal costs.
They then have to make regular repayments to whichever financial institute they borrowed from over a specified time frame in order to close their debt. As part of these repayments, they have to pay off an interest component as well as the amount they borrowed.
2) Buy a property with a 5% deposit.
This approach can be helpful for first home buyers who haven’t been able to save a 20% deposit but whose income can service the loan.
The process is similar to the above except that the borrower uses a 95% lend in order to settle the property. Financial institutions will take out Lenders Mortgage Insurance (LMI) on most lends that exceed 80%. This extra cost is paid by the borrower but it doesn’t protect them. It protects the lender in the event that the borrower cannot pay back their loan.
The extra cost involved means the lender may not lend as much since it increases the borrower’s expenses.
This approach is usually not the best for property investors as it can slow them down from aggressively building a property portfolio.
It may also limit the type of property bought, as it is seen as a higher risk purchase. Certain postcodes, complexes and buildings may be out of bounds under this arrangement.
3) Buy a property using a deposit from a family member.
We often see people get into the market thanks to the generosity and support of family members. Parents will either gift or lend a certain sum of money to use as a deposit. Or, they may release equity from the family home to get their kids started.
This strategy can help first home buyers who may have a regular income but who haven’t been able to save up for a deposit.
As always when borrowing money from a third party, it is essential for each person to seek independent legal and financial advice before agreeing on terms and conditions that are fair for all involved.
4) Purchase properties with a relative.
Instead of borrowing from a relative, some people choose to purchase a property in partnership with a family member or friend. Under this arrangement, buyers can create an agreed upon structure in which they both benefit from the purchase.
For instance, if you had a deposit saved up but couldn’t service the loan, and you had a sibling who could get a loan but didn’t have a deposit, you could purchase it together and decide how to split the ownership.
Both parties would need to seek legal and financial advice in order to set up the structure.
5) Enter a rent-to-own arrangement.
This is when you rent a property with the option to purchase it at the end of the agreement.
Nathan cautions against this approach because there are so many risks involved.
“I have never done one and have never advised anyone to do one because there are so many problems that could go wrong,” he says.
“You don’t know the vendor. They could be going bankrupt or getting a divorce in six months. There are so many elements of risk that you don’t know about.”
He especially cautions against Vendor Financing, which is where you pay the vendor a deposit and make repayments as you would a traditional loan. The difference is, you would be paying them straight to the vendor. Often the vendor will charge you a higher rate of interest than what they are paying, as well as a higher purchase price.
One of the biggest risks involved in these strategies is that the vendor may default on their loan and have the property repossessed. The buyer could lose all of the money they put into it. Not only that, but they would have no legal ownership over the property if this happened.
Rent to own agreements can also come at a much greater cost than traditional strategies.
Usually the buyer enters into a rental agreement for a fixed term at a higher than market rent. They then pay extra each week for the option to buy the property. Sometimes this counts towards the equity of the house and gets deducted from the final purchase price. This isn’t always the case though.
At the end of the term, the buyer still has to get a loan to settle the property for the agreed purchase price as set out at the start of the period. If the market has gone backwards, the buyer may be stuck with an overpriced property. Or, they may not be able to get the loan they require to secure the deal.
6) Buying with a delayed settlement.
One of the other ways to buy a home is delaying settlement – Nathan often takes advantage of this strategy.
He says, in good markets, a delayed settlement allows you to control the asset without owning it for a certain period until you can get the funds to complete the transaction.
This means you can take advantage of a great opportunity when it presents itself and then organise your finance afterwards.
“It comes down to the negotiation,” says Nathan.
He says he usually starts by offering a low price and waiting to see what price they come back with. He then agrees to pay the vendor’s price as long as they agree to delay the settlement for a specified time.
Sometimes this works and sometimes it doesn’t. But, it can be helpful if you know your circumstances will soon allow you to take advantage of a deal. For example, after you lodge your tax return or coming in to money from savings or the sale of an asset etc.
7) Buying an option to purchase a property.
Nathan says this strategy is similar to a delayed settlement, but harder to get vendors to agree to. In this approach you could sign an option over the property which means you have the exclusive right to purchase it at whatever fixed amount of money agreed to within the timeframe set out.
“That way, you can sell that option to someone else and then they have the right to buy the property instead of you and you can make money via the spread.”
“But, I don’t try to get into those sort of things because there are a lot of elements of risk attached.”
“I generally look at a normal straight up and down purchase or a delayed settlement to accommodate for my own personal situation at the time.”
In any case, whichever strategy you use to purchase a property, make sure you have a clear understanding of the terms and conditions, including your rights and responsibilities. Because when it comes to laying down such a large sum of money, you need to know what you are in for and minimise risk at every step of the way.
If you have any questions about ways to buy a home, let us know in the comments section below.