Saturday, November 20, 2010

Spending everything on the house

Housing in Sydney isn't cheap. Particularly anything within 30km radius of our CBD. We were at a friend's house for her birthday BBQ. Almost all of us aspire to buy a house eventually with the backyard and space so that we can have cats and dogs as pets...and kids too I guess.

The wishlist:
* 3 bedroom (or more) house
* 2 car garage
* 600-700 metre square property - this ensures a backyard
* Within 30km radius of CBD
* Close to shops, public transport (trains + buses), schools and arterial roads (motorways and main roads), parks
* Proximity to the beach would be a dream (this requiring a few millions!!)
* Facing east for morning sun

The reality is that almost all of us live either with our parents, in apartments, town houses or villas. Town houses and villas are more spacious but has no yard. Houses can cost anything between $600,000 to a few millions in the 'desirable suburbs' and the starting points are 2 bedroom houses with no carpark. Or 2 bedrooms, with car park but no yard.

So for anything feasible for an average couple with two cars and planning to have kids, it needs to be at least 3 bedrooms, with car space for two cars and a backyard for the 'potential' kids.

One set of couple, are essentially engaged and they bought an apartment in the Upper North Shore (where the house prices start off from around $1.2 million). Problem is, they said that they spent all their money on the apartment and haven't got enough to buy the rings or get married. This isn't the exception though. Another friend said that she couldn't get married either because they were in the exact same situation.

Their mortgage payments are too much and they can't afford to save up for the wedding.

Mortgage versus diamonds and getting married

With a property, you have a home that you can live in. If they're directing all their spare funds towards their housing mortgage instead of a wedding, it's a form of forced savings. Despite not having much discretionary income left to spare, the savings are at least going towards building housing equity which is ultimately increasing their net wealth. That's a good thing.

The cost of getting married versus paying off the mortgage

Spending $10-$15k, on a diamond ring and then $40-$50k on a wedding is rather insane but that's the average nowadays. To be conservative, if the ring and wedding costs $50k in total, once it's spent, it's gone and it's a sunk cost. If however, you were to use that $50k to pay off the mortgage, you can save hundreds of thousands of dollars in interest savings. I'll illustrate using two scenarios:

Base assumptions: Interest rate of 7.5% fixed for the duration of the loan, 30 year mortgage loan

Example 1: $100,000 mortgage loan
Using the $50k to pay off the mortgage will save you $135,254 in interest over the duration of the loan. Instead of paying $151,721 in mortgage interest, you only pay $16,467 in interest

Example 2: $300,000 mortgage loan (the reality for most Sydneysiders)
Using the $50k to pay off the mortgage loan will save you $245,249 in interest over the duration of the loan. Instead of paying $455,155 in mortgage interest, you only pay $209,906 in interest

So for the average couple in Australia, with the average mortgage of $300,000, spending $50k on their diamond ring+wedding, the cost of marital bliss means paying an extra $245,249 in interest. If you're interested in trickier maths, assuming the couple pays the average 30% tax rate, to earn that $245,249, they need to earn a gross income of $350,355 (before tax).

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