Servicability barriers and long-term strategies

Hi all,

My partner and I recently purchased our first home. We are now starting to piece together our medium/long-term plan.

We are fortunate to both be in a position where our income will increase and purchasing costs won't be too much of a problem (Doctors w/ access to 90% LVR no LMI loans), which we are very grateful for.

However, we are learning that the main barrier we need to plan for is servicability limits. The long-term plan is for property/equities to be a vehicle to financial independence in our mid 50's (currently in mid 20's).

An example of this is we were investigating buying an IP in the next 1-2 years vs. a new PPOR in 3-5 years and transitioning the current PPOR to an IP.

Some numbers:
Joint income = 200-250k gross (overtime varies a lot in medicine but this will be our likely income range for the next ~3 years)
Current PPOR value = 750k w/ 90% LVR (just purchased so no equity yet, except the deposit)
Strategy #1 PPOR in 3-5 years = 1.5M (terrace house in inner Melb)
Strategy #2 IP in 1-2 years = 750k (art deco old style apartment in inner Melb)
No CC debt / dependents etc.

It seems the main negative of strategy #2 is that post buying it we may have to wait quite some time until our servicability allows for the purchase of a subsequent PPOR. It does have the benefit of spending more time in the market.

To counteract this does anyone have any long-term strategies we can implement now to prevent us running into a road block with respect to servicability, beyond increasing income (this will happen with our jobs)? I'm particularly cognisant that the strategy of high-yielding properties doesn't help as much now compared to pre-2014 due to servicing calculation changes.

Thanks!

 

Selling property can be the way to go further, but it is a costly thing to do.

The other is to try to get the end main residence now and rent it out.

 

Pretty unlikely that servicing will allow for turning the current property to an IP, and buying a new PPOR for 1.5m. But that's just a guess, you'd need to see a broker and run the numbers.

Strategy #2 may be a good option, but I'd aim for a higher growth asset in Brisbane/regional-NSW/VIC rather than an apartment in Melbourne. Then you can sell the 1st PPOR to upgrade to the next PPOR.

Would you consider turning the current property into an IP and rentvesting? That's a long term strategy to improve serviceability. Especially as doctors that may even suit better as you have more flexibility in job opportunities?

 

The issue here is that the serviceability bar is likely to change in the future, making it harder to borrow, we just don't know exactly by how much. This makes it hard to work on future borrowing projections as what you can afford to do today may change significantly in the future. We do know that the serviceability floor rate is moving up 0.5% from next month, not a huge difference but likely just the first step in making borrowing tighter.
Serviceability today, based on those numbers, renting the existing property out and buying PPOR for $1.5M could be do-able (assuming you already have the deposit) but without a crystal ball it's hard to say where serviceability will be in 3 to 5 years.
I think focusing on increasing income and reducing debt is always going to help when looking to borrow more.

Will $1.5M be enough to get a terrace house in inner Melbourne in 3 to 5 years time?
What's the plan for deposit? Savings? Or do you need growth in the existing property to fund the deposit and costs of the next purchase?

 

Thanks Lindsay that's very helpful.

I love property as a means of building wealth, I believe values will increase over the next 30-40 years at a rate sufficient to achieve the outcome my partner and I imagine (increases will be much less than the last 30-40 years though imo). However, I am starting to worry that current servicing rules and as you describe, future changes will prevent it being feasible for the vast majority of investors.

We are fortunate our incomes will increase gradually over the next ~7 years, then make a decent jump after that (once we finish our specialty training - what the jump is to is very unclear until we decide what we want to do).

You raise a good point about the terrace house future value. I am assuming a 5-7% return over the next 3-5 years, so what is currently $1.2M (what we hope to buy) is what we plan to buy for $1.5M in the 3-5 year period.

Purchase costs will be savings, however, we time will tell if our current PPOR has any value increase. In which case we would use some of that as a adjunct.

 

To access that equity you will need to borrow though, which only increases your serviceability issues. So you'll need to save enough or have a sufficient increase in income, or sell the property.

 

The good news is you're in a profession where you can probably increase your income significantly. A household income of $250k for two doctors is actually fairly conservative, the future will almost certainly give you opportunity to increase this.

This doesn't overcome serviceabilitly issues (everyone has a limit), but you may be able to find ways to give yourselves a boost from time to time.

Beyond this, the advice is really the same for everyone. Understand your strategy and make good investment decisions that are in line with that strategy. Constantly save. Pay down non deductible debt as a priorty.

One challenge I see people get into regardless of their income is they use all the borrowing capacity for one or two purchases. Borrowing capacity is a resource, not a target. If you're spending $1.5M on a purchase, understand why you're spending at this price point and not a different one.