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How We’re Buying A House During Early Retirement

March 1, 2022


You’ve probably heard by now that we recently purchased a home.

Given our early retirement scenario, the questions have started coming in:

How are we paying for it?  Did we get a new loan?  Are we selling investments?  How does this change our FI numbers and living expenses?

I’ll get into all that, plus our plans for the house, why we decided to buy, and thoughts on financing a home purchase after retiring early.

Let’s get into it!

 

The purchase

So what did we buy?  Basically, it’s a 1970s house in pretty average condition.  3 bedrooms.  1 bathroom.  810 sqm block.

It backs out onto the large parklands connected to Lake Joondalup, down the road from our current rental house!

We’re spending a bit of money to make it a bit nicer before we move in.  For example, we’re getting it tiled throughout and freshly painted.

There’s plenty of other things planned, which we’ll get done over the next few years to spread out the cost (and minimise stress lol).  Maybe we should do a before/after shots with an update later!?

Will I be doing the reno work myself to save money?  Nah!

The truth is, I’m lazier than I am frugal.  So the laziness wins out.  Yes, I could learn the necessary skills, but I also tend to be pretty impatient when trying to figure things out.

But more than that, I’m highly protective of my free time.  When I think about the large time investment and the likely stress involved, it doesn’t stack up for me.

If I wasn’t doing anything else, then sure.  But with the blog, podcast, trying to write a book, turtle stuff, exercise, socialising, reading, being a doggy-daddy, while aiming to be not-busy and in a state of anti-stress… it just doesn’t feel worth it.

As for the price, after most of the improvements, the cost will come in at around $500k.  That will sound relatively normal to everyone except those living in Sydney and Melbourne, but still, Perth is cheap!

 

Why that property?

We were quite fussy with what kind of house we wanted.  The location had to be on this particular street adjoining the parklands and lake.

After living here for 4+ years, I almost can’t imagine living in a normal street again with neighbours in each direction.  Talk about lifestyle creep 😉

We also wanted the property to have as much open yard and as few structures as possible – pools, sheds, large paved areas – none of that shit!

The plan is to enjoy the yard space, have room for the turtles to come lay their eggs, spread out Mrs SMA’s plants and little trees, while also making a pond and habitat area for frogs, lizards, etc.

We’re also planning some stealth fruit tree plantings and natives in the parkland outside our fence.   To enhance the view, provide more shade and habitat/food for birds.

 

Why now?

Well, after reaching FI we decided to move to a quieter area of Perth with more open space and nature.

Given we weren’t sure if we’d like this area, renting made more sense than buying.  But now that we’ve been here for almost 5 years, we’re confident we’ll be here for a long time.  And since prices are pretty affordable, buying makes sense.

The local market is relatively solid at the moment.  The first private inspection (before the first official home open) had a few interested parties, so we had to move quickly.  Overall, we didn’t have much leverage in the negotiation, and basically ended up paying the asking price.

So not a dream outcome, but not bad either.  Given how much we like this location, I’d actually be willing to pay a lot more if prices happened to be higher.  Speaking of which, how exactly are we paying for it?

 

How are we paying for the property?

OK.  So the initial plan was to do what’s called a security substitution.  Essentially, we sell an investment property, while buying this house, and have the two properties settle on the exact same date.

That allows the bank to take the new property as security and release our old investment property to the new owners.  This keeps the loan facility open, and the sales proceeds more or less pays for the new property.  More on this strategy soon.

So what happened?  Well, our offer being ‘subject to the sale of our property’ was rejected.

The seller obviously wanted a clean offer with no mucking around.  We had to come up with a new strategy.

 

Funding secured

When our initial plan didn’t work, we weren’t left with many options.  Here’s the new play:

Step 1:  Buy the house with cash.  We do this by selling shares and using our cash buffer.

Step 2:  Sell our investment property (IP).

Step 3:  Upon settlement of IP, transfer the loan to the new property.

Step 4:  We receive the sales proceeds (after costs).

Step 5:  Reinvest back into shares, and top up our bank account.

Step 6:  Continue monthly investing into shares and slowly selling down our IPs.

What about tax on our shares?  Sharesight is showing me that we do have some capital gains on the shares we sold.  Despite that, Capital Gains Tax (CGT) is going to be basically nothing.

How?  The shares we sold are in my name, and I have some income tax losses from previous years where I earned zero income yet still had negatively geared properties.

The result:  Our investments end up the same as before.  We have the house.  And everything is basically the same as our original plan.

For a moment, I assumed we’d simply end up with a paid-off house and we’d finish at Step 2 after replenishing some cash.  But then while talking to Pat after one of our podcasts, he asked whether Step 3 was possible.  That’s when I reached out to my broker to tell her the situation and she said it was doable!

So let’s talk about this strategy since it’s not well known, yet very useful in certain circumstances… especially for early retirees!

 

Security Substitution / Loan Portability

In essence, you’re selling one property, buying another one, and simply dragging the loan across.  This can be extremely handy given there’s no need for a new credit application.

So if your employment situation or lending criteria has changed, yet you have no problem paying the mortgage, a security substitution can avoid the pain and frustration of having a loan denied unnecessarily.

As explained earlier, this can all happen simultaneously at settlement.  Or in separate steps as we’ve done.

In practical terms, your leverage matters.  If you move from a $600k property to a $400k property, you can’t drag across a $400k loan!

It would need to be paid down to $320k beforehand, to keep the loan-to-value ratio under 80%.  This can be done with the sales proceeds from the first property upon settlement at the same time the loan is transferred.

I’m told a good conveyancer, who has done transactions like this before, is incredibly important.  There’s also typically a fee payable to get a mortgage broker to do the legwork and facilitate this process ($2k for example).

Because there’s no new loan being established, they aren’t paid anything from the bank to make this happen.  It would be possible to do this yourself, but it’s is something I want to go smoothly, so I’m happy to pay!

It may seem a bit tricky, but security substitution is a very useful strategy for people in the FI community to get familiar with!

 

More info on security substitution

For more guidance and tips on this strategy, I reached out to my mortgage broker Deanna Ezzy (from More Than Mortgages) with a few questions.

So which banks will and won’t do this?

Deanna:  The major banks all do it, and their subsidiaries (CBA, Westpac, NAB, ANZ, Bankwest, St George, Bank of Melb, Bank SA), Macquarie, AMP, ME Bank, ING.

Is this only offered with certain loan types?

Deanna:  You can do a substitution of security on any type of loan (IO, P&I, Package, Basic, LOC).

And does the loan have to be below 80% LVR?  

Deanna:  Some lenders will allow up to the same LVR that the loan was originally done, most want the LVR to be 80%.

Are there restrictions on property types or locations?  

Deanna:  Generally speaking, its standard bank criteria, i.e. as long as the bank would allow you to purchase (or refinance) a certain property, then you can ‘port’ a loan to that property.

To further expand on that, if the property is in woop-woop or inner city, the LVR for that location (whether buying or refinance) might only be 70%, at which point you’d need to ensure the LVR was 70% when you ported the loan to that property.

That said, some lenders only allow the security swap to happen if the properties are in the same state.

Anything else we should be aware of?

Deanna:  The new property owner on title, must match the borrowers on the loan, i.e. you can’t port a loan from one property that’s owned in a Trust, to another property owned in personal names.  Nor can you port a loan that only has 1 borrower to a property that is owned by 2 people.

Some banks will allow the loan to move from “property” to “term deposit” to “property” – this is called a “Deposit under Lien”.  Other lenders will only allow the loan to move from “property” to “property”.  You’d need to check with your bank what they will allow you to do.

Awesome, thanks De!

 

Purchasing a home and early retirement

After leaving the workforce, it’ll be extremely difficult to get a new loan in retirement.

Banks really aren’t interested in investment income (especially shares), and worse if you still have other debt… that’s us!

They want a plain vanilla easy to understand Joe and Mary Bloggs who work their full-time employee jobs and earn a steady paycheck.  Anything outside that seems to be in the too risky/too hard basket.

Vanilla Bank Risk Mitigation Department 😉

From this position, your homebuying strategy has to change.  You’ll likely have to pay cash by selling investments.

Nothing wrong with that, since a paid-off home will dramatically lower your expenses.  But if you’d rather keep your investments, consider security substitution!

Obviously, if you think you’ll want to own a home later on and you don’t want to offload investments, then consider buying before you retire.

In any event, there’s no right answer and nothing to really worry about.  Just have a think about which approach feels right for your situation.

Some people will point to this is another fearful reason (excuse) to stay inside the protective bubble of permanent employment.

Don’t succumb to this nonsense.  Just understand there are practicalities to consider, so either plan ahead or find a simple workaround.

 

How does this change our FI numbers and living expenses?

Once the security substitution is complete, I don’t think our spending will be very different to our current expenses.

The mortgage (including principal) may end up close to (or cheaper than) our current annual rental costs of $22,000.  Of course, add in several thousand extra for water rates, council rates, maintenance, etc.

But you could also deduct the principal since it’s not really a cost, as this money becomes home equity and eventually results in zero payments.

However I slice it, paid-off or not, our required wealth for FI would remain the same at a little over $1m.  I don’t really share net worth numbers on the blog, but suffice to say that number is covered.

So after this purchase, nothing has really changed.  We did incur some hefty costs though, the biggest being selling agent’s fees and stamp duty!  There’s also the renovation costs, but we’re basically including those in the home price.

 

Final thoughts

So that’s the story!

Our situation is a little different from most in the FI community, given our investment properties and retirement-style scenario.  So I thought it was worth sharing our experience in buying a house and this unusual financing method.

Security substitution is good to be aware of as a future early retiree.  It may come in very handy one day, so I hope it’s been interesting for those of you hearing about it for the first time.

Settlement is about a month away, and we’re looking to get in there and start making it the way we want (inside and out).

Plenty to organise… better get to it 😉


Home loans:  By the way, if you want help with anything home loan related, you can reach out to Deanna and her team at More Than Mortgages.

She knows her stuff and she’s helped us a lot over the years!  So you know, if you end up getting a loan with MTM, this blog may receive a referral fee.  I only recommend things I use myself and genuinely believe in.

31 Comments

31 Replies to “How We’re Buying A House During Early Retirement”

    1. Haha yes, she certainly does already here at our rental. I can only imagine her joy of pottering around in the new patch 😉

  1. Congratulations and thanks for sharing this strategy! I had never heard of the concept. We have been speaking to our mortgage broker about possibly buying a home soon. We were pretty shocked how much our borrowing capacity has decreased since we moved to part-time work. I might bring this strategy up with our broker. Good luck with the renovations and the move!

    1. Cheers 🙂 Oh yeah, borrowing capacity can be quite fickle even with small changes in circumstances.

      Sounds like security substitution could be a possible solution for you, worth looking into. Thanks, and all the best with your own plans!

  2. Congratulations Dave! And thanks for sharing these Jedi tricks. Very handy to keep in our back pockets when that FI time comes.

  3. Where there’s a will there’s a way!
    Well done on pushing through and finding a way to get it sorted.

    It’s such a shame that Aussie banks require a job to lend even if you’ve got plenty of assets and income they only accept partial investment income.. I guess they just don’t trust us not to sell our investments and go on a gambling spree or something!

    We also want to buy again at some stage, however we do have capital gains tax to worry about – first world problems! Could possibly take a job just for 3 months to get a loan but I really don’t have time for jobs anymore. Funny how people say FIRE will be boring but it’s just the opposite, busier than ever.

    1. Thanks for that Dan! Yeah there definitely seems to be a gap in the market where banks should be more open to people who really have their financial shit together but aren’t quite at ‘sophisticated’ investor level. But they do have guidelines and regulations to follow I guess.

      Haha first world problems indeed 😉 Getting a full-time job to qualify for a loan is an extremely unattractive proposition after a taste of freedom, couldn’t agree more!

  4. Congratulations Dave and Mrs SM!

    Another great article- clear, concise and jam pack with useful and thought provoking ideas.

    Can’t wait to see updates on the house in future articles.

    All the best.

  5. Good article.
    One thing I still don’t understand is how your living costs not increase with your ppor. Your current rental expenses may be used to cover the P&I of the ppor, but won’t you lose the rental income of the IP you sold? As your original plan is to sell IP to subsidy living costs, that funding is now tie to your ppor and you have to find another source of cash to live off. Also, although you spread Reno costs over the years, they are still additional costs?

    1. Right now the rental income pays the loan, and we pay our rent (there is no leftover rental income). Remove the rental income and remove our own rental costs and the situation is equivalent.

      We’re using the equity from selling down our properties as part of our retirement cash, not the rental income (the properties are roughly cashflow neutral, or worse after principal payments). Our reno costs I’m building into the purchase price like I mentioned in the post. We can still use cash from the IP sale for this, whether it’s immediately or over a few years.

      In case it’s not clear, we still have multiple properties to sell off, so there will be future cash coming from there we can use to increase our investments/live off/etc. Not just this one IP. Hope that helps.

  6. Congratulations Dave! It is interesting how banks favour employees instead of equity owners, and particularly interesting knowing that banks “may” decide to get employees redundant to keep paying dividends to shareholders.

    1. Thanks Pablo 🙂 Haha yeah that is interesting, though I guess in many cases employee income is generally more consistent and reliable (for paying off a loan) than share income.

      People will generally get another similar job if they lose that one. But to rely on someone’s investment income assumes they won’t do anything dumb, and with shares, unfortunately many people start trading or do all sorts of silly stuff and end up ruining their portfolio! Would be good if they were more open-minded and not so overly conservative in that area though.

  7. Hi Dave,

    Thanks for sharing this, Interesting stuff. Reading this I had a few questions (Sorry).

    My understanding is that the loans need to be really clear about what is an investment loan vs non deductible residential loan. As part of the process is the existing investment loan discharged and a new loan setup for your PPOR?

    I am thinking something like this would happen as owner occupier loans have a lower rate than an investment loan. I did not think they transfer, rather one loan is paid out and the funds used straight away on a new loan.

    I am also interested if you encountered any surprise fees or charges to do this process and any other tax considerations around the process.

    1. Hey Nat. No, the investment loan is never discharged. If it is, that requires a new loan to be established and new credit application.

      When we move into the place and it becomes a PPOR, we can show the bank this and then they’ll move us to a PPOR interest rate (without needing to refinance).

      There is a broker fee for doing this of a couple thousand (may depend on broker) as the banks don’t pay them anything for organising this, so otherwise they’re doing all the work for nothing (I’ll add this to the post). You could do it yourself, but I’m happy to pay to ensure all goes smoothly.

      Lastly, the only tax outcome would be in relation to selling the IP as per normal, if that’s what someone is doing. If it’s a PPOR, then no tax obviously. Hope that helps!

      1. Thanks for your patience and explanation. Okay, I think I now get this, please correct me if my understanding is wrong.

        So at step 3. This must all happen on the settlement day when the Investment property is sold. There is just an extra step of changing the security of the loan to your PPOR and the balance of any funds transferred. This is all possible as the owners of the 2 properties involved are in the same names. As solicitors are used at this stage, they can do this work as part of the settlement scope.

        Also to make step 3 happen does the bank make you get a valuation done on your PPOR prior?

        If yes, do they make you pay for this or is it just an arm chair valuation done behind a desk at the bank?

        1. Yep that sounds correct and is my understanding too. As long as clear instructions are made on any loan paperwork, and the conveyancer knows exactly what is happening, then it all happens simultaneously.

          And for the transfer, yes I’m 99% certain the bank will require a valuation on the new property to ensure the loan being transferred is a suitable size and LVR will be acceptable. As for who pays, I have no idea. Given it’s probably a few hundred bucks or something, I don’t care about paying. For me, the various fees payable is a small price to pay for keeping access to a $400k loan facility lol.

  8. Congrats on the new home. Exciting times and hopefully not too many nasty surprises with such an old house. Nothing really to add but to just stare in awe about the bloody cheap housing in Perth! Pipe dream fantasy stuff for us here in Sydney unfortunately!

    1. Thanks Christopher! Haha yeah, lets’ hope so. I’m sure there’ll be a few things to fix that we come across, but hopefully nothing huge 🙂

      It’s funny because the locals still seem to think housing and rents are expensive despite being basically the same price as 15 years ago! People simply complain and stick with the ‘life is hard’ narrative almost regardless of the situation.

  9. Dave, the interest on the loan won’t be deductible going forward as the money from the loan was used to buy an investment property which will then no longer exist.

    So you would need to loan recycle – pay the loan off in full (or very close) and redraw to buy the shares. The owner of the shares would then get to claim the interest (if a trust you would need to onlend to the trustee under a written loan agreement).

    Terryw
    Tax lawyer

    1. I understand that Terry, thanks. The interest is not deductible anyway, as all the debt related is for IPs we no longer own. Not sure if we’ll recycle at this stage, we invest using two separate accounts so it’d get a bit messy and possibly not something I can be bothered with given our low tax situation. Still considering 🙂

      1. If you don’t debt recycle you are throwing money away really.

        The interest can be a cost base expense against the capital gains of the shares when sold so still worth doing even if your personal income is low – just don’t claim the interest.

        1. Cheers Terry. Can you elaborate on the ‘cost base expense’ and how that would work in practice? Haven’t really heard that before. Are you saying I can stack up the interest costs over the years and they form part of the cost of my shares, reducing future possible CGT? If I don’t claim along the way that is.

          1. Hi Dave

            Yes, basically the CG will be the sale proceeds less the costbase. So the bigger the cost base the smaller the taxable capital gain. Cost base is worked out with the purchase price and certain holding costs that haven’t otherwise been claimed. This includes interest used to acquire the shares. So if you have borrowed to buy the shares but haven’t claimed the interest against your dividend income then it can be a cost base expense and be used to reduce CGT when the shares are eventually sold – by you, by your estate if sold after death, or by the person that inherits them (when they sell the shares)

          2. Thanks for confirming Terry! That’s interesting, I hadn’t heard that being done before. Good to know 🙂

  10. Great share mate…I’d never heard of Security Substitution before. Congrats on the new home. I’ve also recently bought (not too far from you in Mullaz) so if I recognise you around the traps I hope you don’t mind me saying g’day as you’ve been a huge inspiration to me the past few years!

    1. Thanks Benny, appreciate that mate! Congrats on your own purchase! Not at all, definitely stop and say g’day if you happen to spot me out and about 🙂

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