What level of gearing should I accept for my first investment? Ask Margaret

Hi Margaret

I'm buying my first home in Melbourne and I am worried about how this will effect my investments later if I borrow at 90%.

Does it matter, or should I be saving for longer or buying cheaper?

Ive been told that I should buy as soon as I can even if it means LMI?

Regards,

David

Margaret's answer on the next page. Please click below. 

Hi David,

I always wonder who is doing the telling when investors say ‘I have been told to…’ 

Very often it is either someone wanting to sell you something like a property, a loan, or a training program, or a well-meaning friend who may have done some reading or been to a course. Or it could just be that they did whatever it is they have been told to do and experienced some success from it.

The important thing about any property investing strategy is that there is simply no one size fits all approach. 

When it comes to the level of gearing you should be undertaking, there are many things to consider such as:

• Your personal risk profile – are you conservative, balanced or assertive? Your results from profiling your risk will determine the level of gearing you should use.
• Your time till retirement – if you borrow 90% and it all goes horribly wrong, how many more years of earning capacity do you have to get back on top?
• Your present income levels – if your property experiences vacancy and you have high levels of debt, can you maintain the mortgage?
• The security of your job – if you are unsure about your tenure then you will not want to be taking on high levels of borrowing.
• Your other assets.  If you have little in the way of other assets, a 90% loan can be a big mistake.
• The lender’s mortgage insurance – at up to 3% of the loan amount, this will further reduce your equity to a very risky 7%. Add stamp duty and borrowing costs and you will likely owe more than your property is worth.

One of the things I find about proponents of high levels of gearing, such as a 90% loan, is that their thinking is what I call ‘good time’ thinking.  They operate out of a misplaced notion that property will always go up and that it will only be a matter of time before your equity increases. 

Nothing can be further from the truth and, in addition to the fact that there are many moments in times past when property has indeed fallen (such as after a crazy period of buyer frenzy such as we have been seeing in Sydney), there is a good chance tha, as a first time investor your first property may well perform far less well than you had hoped. 

You are new to this and your first property purchase brings with it the greatest risk you are likely to ever have of choosing badly, not doing the research well or falling prey to a spruiker who sells you something with an upside bigger to him than it is to you!

There are many things you can do from here, including saving more, biting off less with a cheaper property, or maybe even seeing if your parents are interested in helping out a little by offering a little bit of their equity to get you started. 

Whatever you do, don’t try to do it alone.  Get some good quality advice from someone with no vested interest in what you are about to do, and get educated before you start.

Have a property question? Ask Margaret!