When it comes to some of the biggest decisions in life, it is important to pause and ask ourselves “how ready am I?”
Marriage, children, career change – we often don’t have the answers to all the questions, and realistically we shouldn’t expect to, but we inherently know, or have been repeatedly told, it’s important to consider if we are ready for what might happen.
However, some recent research commissioned by Westpac to gain an insight into the financial literacy (or financial understanding) of home buyers raises the question of whether people are taking enough time to fully understand what they are about to commit to for one of the biggest financial decisions in their lives.
Pleasingly, a number of home buyers are undertaking some form of research before making a purchase.
For first home buyers, 65 per cent spoke to a professional – their bank, broker or financial planner – and for those who already own a home, the rate was higher at 70 per cent. First home buyers were almost as likely to use digital resources as consult a professional (61 per cent compared to 32 per cent for existing home owners) and were also more inclined to seek insights from friends, family and colleagues who had purchased homes.
However, the findings suggest major gaps remain in the understanding of key (and in some cases, fundamental) concepts associated with home ownership. Perhaps most notable, around half of those looking to purchase their next home could not correctly define what “equity” means, and a similar number didn’t fully understand the concept of mortgage offset accounts.
For first home buyers, the results were even more concerning.
Only 30 per cent were able to appropriately define what was meant by their equity in a property – the difference between a property’s market value and a borrowers outstanding mortgage – and only 21 per cent could appropriately describe an offset account. Likewise, almost 80 per cent of first home buyers don’t know exactly what lenders mortgage insurance is, with 31 per cent having never heard of it. The findings about LMI – which borrowers pay and insures their lender against default – were slightly less eye-opening for homeowners, but not by much.
With the Reserve Bank tipped to cut interest rates even further below record lows and hopes rising that the property market is stabilising, it may be tempting for some borrowers to not overly worry about being across all the details.
But what does it mean if – or when – rates do eventually increase or your circumstances, such as employment, change?
Understanding what you own versus what you owe (ie equity) and ways to reduce your interest expenses (eg an offset account) may become even more important as budgets tighten. It’s an all the more timely consideration after the government’s recent unveiling of a $500 million plan to assist first home buyers with deposits of 5 per cent, avoiding the need to pay for LMI (typically for deposits of below 20 per cent).
The research also raises some other interesting questions. If there is a low level of understanding around what for many may be their biggest financial commitment in life, what does it say about other important aspects of financial wellbeing? Particularly in areas where you may not think you even have a choice?
Take your super as an example. If you are an employee, your employer is already setting aside a minimum of 9.5 per cent of your salary as compulsory savings into a superannuation account on your behalf. This is legislated to increase to 12 per cent over time. But do you know how much you have, where it is and how it is invested?
If you make the right decisions, it could even become your most valuable asset in the future, potentially worth more than your home (or at least more than the equity you have in your home).
Whilst the research shows two thirds of people are willing to speak to a professional when it comes to buying a property, historically the number of people willing to seek professional support when it comes to their broader wealth needs is significant less. Perhaps it is the immediacy of obtaining a loan compared to the longer term to be able to access super.
Whatever the reason, one thing remains clear: the more steps you take to become informed, whether it be through speaking with a professional, or undertaking your own research, the greater the level of understanding you will have about potentially life-changing financial decisions.
Just make sure you talk to the right professionals, or do your research in the right place. Whilst a higher level of financial literacy might not make you wealthier in the short term, it might just give you a better sense of comfort that your plans and the decisions you make today will give you a greater benefit in the long run.
The views expressed are those of the author and do not necessarily reflect those of the Westpac Group.