So you are making the exciting decision whether to buy your next home. Now the next step is to decide what to do with your existing one. Is selling the right choice or should you hold on to your current home as an investment property?

More often than not, we have an emotional attachment to the home we live in, so it’s no surprise that many of us would like to keep our current home if possible when we move to the next one.

The problem with this however is it’s not always the right decision financially. That’s because solely relying on our emotional attachments is generally not the right way to make smart money choices. It’s important to understand the pragmatic reasons both for and against keeping and renting out your home.

So let’s explore the options.

 

Firstly, what is upgrading?

Upgrading simply means selling your current home and purchasing one that’s a little further up the property ladder. There can be a number of reasons for upgrading such as accommodating a growing family that needs more space, moving from an apartment to a house so your kids can have a backyard, relocation for work purposes or moving to a better location overall.

Whatever the reason, it’s important to think through the financial aspects carefully. You have probably built up sufficient home equity to be able to afford an upgrade but you should also consider how you’ll fund the move.

What are the benefits of selling your home?

The primary benefit of selling your existing home is that you are likely to end up with a tangible amount of money to work with when it comes to buying your next place. This, in turn, will allow you to be able to make an informed decision about what you can afford and how large your next mortgage can be.

Let’s have a look at this ‘Selling to Buy’ example to shed some more light on this.

Say you sell your current home for $800,000 and you have a $200,000 mortgage. That should leave you a gross profit of $600,000. If the home you want to buy is $1 million, you’ll need to borrow the balance, as well as cover the cost of:

• real estate agent’s commission to sell your existing home
• stamp duty on your new purchase
• legal and conveyancing fees on the sale and purchase
• pest and building inspections
• repairs and maintenance on your new property
• moving costs.

So, depending on which State you live in and your lenders conditions, that means you will likely need to borrow approximately $465,000 to secure your new home.

What are the benefits of keeping your home as an investment property?

If you held onto your current property as an investment, it could give you the benefit of ongoing rental returns and tax deductions, as well as a capital gain over time.

Can you use the equity in your existing home to buy your next property?

Equity is the difference between the current value of your home and the amount you still owe on your mortgage. Pending your lenders requirements, you can use this equity to help you buy your next home if you don’t end up selling your home.

To do this you will be required to have a professional valuation of your existing home done, then you will need to speak to your home loan provider and/or financial adviser to see whether you are able to borrow against your existing property.

Here is an example of how this might work.

Let’s say you decide that you want to retain your existing home, but you will need to borrow the full value of the new property plus stamp duty for a total loan amount of $1,065,000. While that may initially sound a bit daunting as it’s a lot more money -and it is, you need to keep in mind that you will now own $1.8m worth of property.

Depending on what your lender allows, you should also have the option of spreading your loan across both properties you own. This is very important because it means the tenant in your old home (should you decide to rent it out) will help meet the cost of your mortgage repayments through rental income. This may or may not be enough to meet the entire cost of the loan over your old place, depending on how you structure it.

Alternatively, if there is a shortfall, it means your investment property is negatively geared and you may be able to offset your loss against your tax obligations.

Don’t Forget To Include Lenders Mortgage Insurance

Seeing you’ll now own two properties and you’re borrowing a larger amount of money, your loan-to-value ratio (LVR) is subject to increase. If for instance, your Loan to value ratio goes above 80% on either your new or existing loans, you may be required to pay Lenders Mortgage Insurance (LMI), which you will need to factor into your costs as well.

Furthermore, if you end up increasing the loan on your existing property, you’ll also be required to go through a new credit application process when you take out your new loan, even if you already have a loan in place for your current home. You will need to speak to your financial adviser and/or lender about any extra considerations if you change your home into an investment property.

Set up a budget to help you decide

We cannot stress enough how much putting together a realistic budget is a key factor in helping you decide whether to set up an investment property. Together with all your existing monthly expenses, make sure you take into account:

• Loan repayments on your new property, as well as on your current one.
• Projected rental return on your investment property
• The cost of engaging a property manager
• Ongoing maintenance costs for both properties
• Insurance on both properties

It is also strongly advised that you consult your accountant or financial adviser about the tax implications of both decisions. Generally speaking, selling your home (if it is your principal place of residence) may mean you’re exempt from capital gains tax (CGT). However, if you decide to keep your current home as an investment property, you may be required to pay CGT proportionally at the time you sell it.

We would also suggest that if you do decide to retain your existing home as an investment property, that you get it valued before you rent it out, as well as any fixtures and fittings, as you may be able to claim depreciation for these on your tax return once it becomes an investment property.

Do I Buy Or Sell First?

Ahh… the big question everybody wants to know the answer to. If you make the decision to sell your home, do you do it before or after you buy your new property?

Selling first is typically the traditional and probably safest strategy as it means you have a concrete budget to work with. However, buying first can be ideal in a competitive market, when you’re confident your property will sell. That being said, because you now would be funding two properties, you may need to acquire bridging finance until you’ve sold.

Some Final Words

With many more of us traveling and relocating for work, it’s more common for our homes today to become investment properties tomorrow. It’s important to understand what you should be doing to keep your options open and make smart decisions about buying and selling based on facts and not emotion.

Factoring in all of the above, making the right decision really is a question of balancing local real estate market factors with your own financial needs, budgets, and goals. Take the time to talk with your financial adviser, accountant and/or lender as well as experienced real estate agents in your area about how the market is moving before you make your final call.

But most of all, remember to enjoy the process, as buying a home is a really exciting experience whether it’s your first, second or third and should represent a very happy time in your life.