I often get asked by people new to the property market about how they should structure their investment property loan. The answer is never simple since there are many things to consider including fixed vs variable rates, interest-only vs interest+principal, your cash-flow situation, your investment horizon and the likelihood of future rate rises.
Fixed vs Variable Rates
Variable rates will generally cost you less in the long run. You can consider fixed rates when you know there are significant rate increases in the near future and where your cash flow may be severely hindered as a result. Although, if you are in this position in the first place then you may have over-extended yourself.
One trap that new investors get in to with fixed rates is the possibility of having to be pay rather large "break costs" should you need to sell or refinance during the fixed rate period. Banks will look for you to pay out interest on the remaining term of the loan, especially when interest rates have dropped since you first took out the loan. This can amount to tens of thousands of dollars. Be careful with fixed rate loans when you plan to sell your property in the short term.
Interest-only vs Interest+Principal
Having an interest-only loan will give you more cash flow. If you can use this extra cash flow in a financially productive way then it is fine to stay with interest only loans especially given the interest expense is tax deductible.
Remember that you don't treat your investment loan the same way as you would treat the loan on your home - your aim should not be to pay off the investment loan as fast as possible if you think you can earn more by investing elsewhere. Consequently, paying off principal on an investment loan is not a priority. You are aiming to grow your wealth via capital growth.
Setting up an Offset Account
Rather than pay off the principal, you can set up an offset account and have all of your spare cash, including the rent, be placed into this account. The offset account will offset your loan, meaning it will save you on interest. One extra advantage of this is that you can still access these funds for future investment purposes without having to go through a re-draw facility or apply for additional financing.
Getting the Best Rate
The interest expense is often the greatest expense of an investment property so one of the most important considerations is the interest rate itself. Push your banks hard and definitely shop around. If you are not getting at least 1.0% off the bank's standard variable rates then you are probably losing out. Saving .1% or .2% can mean a lot, especially on larger loans. Call your bank today and ask for a better deal.
Everyone likes ice cream right? Do you feel the same about debt?
There is good debt and there is not-so-good debt.
The not-so-good debt is the one that has a high interest rate and is not tax deductible. Examples of no-so-good debt includes credit card interest, personal loans and car loans. Too often I see clients with great cash reserves sitting in their bank earning 2% interest and they still have a car loan there costing them 12%-15% interest for the next 5 years. It makes no sense to me.
If you have the cash sitting in the bank then pay off your credit cards in full each month so you don't get stung with interest. If you still have spare cash and a non-deductible car loan then pay out your car loan.
And finally, if you have a home loan then consider setting up an offset account and dropping your remaining spare cash in there. This will offset the interest on your home loan and effectively give you much better returns than the 2% you are earning in a term deposit.
I also see people with home loans with interest rates way up over 5% when they could refinance and get a rate closer to 3.7%. A $500,000 loan at 5% refinanced this way would save $6,500 per year in interest. Or a whopping $65,000 over 10 years!
Get on top of your no-so-good debt and you will be able to eat a lot more ice cream!
Contact us if you would like some help with any of these concepts. General advice will cost you nothing but may save you a whole lot more.
Please share this with anyone you know that would like to get on top of their debt faster.
A common question by Australian investors seeking advice is whether they should invest in property or shares. According to the 2017 Russell Long-Term Investing Report, residential property has done extremely well over the past few years, fueled by historically low interest rates. Australian shares have a big tax-advantage through the franking of dividends. If you had the choice, which would be the best investment?
The answer is, if you can, diversify and invest in both.
Why? Diversification is the key to removing volatility from an investment portfolio and having all your eggs in one basket is opening yourself up to more risk.
Investopedia defines diversification as "A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio constructed of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio."
The 2017 Russell Long Term Investment Report lists Australian residential property and Australian shares as the top two for averaged returns over the past 20 year year period. Both asset classes have done well over the long term and both are good growth classes.
The Russell report shows that Australian property has done especially well over the past few years due to the low interest rate climate. Borrowing for residential property investment has been relatively easy and households have been able to take on more debt. However, if interest rates climb over the coming economic period then the great growth in residential property values that we have been experiencing will dry up very quickly.
Australian shares may be due for a resurgence, especially if the economy picks up and investors start to shift their sights away from property. Australian shares also provide the benefit of franking credits, where company tax paid is passed on through to Australian investors, provided a tax-efficient boost to earnings.
Don't stop at Australian shares either. The ASX represents around 2% of the global economy so picking up some international shares via an exchange-traded fund (ETF) will also diversify your share portfolio significantly.
So if you have the option to invest in both Australian property and shares then do it. If you only have property then be sure to consider diversifying to shares. More diversification in your portfolio is a good thing since it will help reduce the volatility of returns.
Identification for each applicant
Proof of earnings for each applicant
Deposit and other loans evidence
Purchase price (not required for pre-approvals)
For refinancing only
Interest-only lending has been traditionally very popular with Australian residential property investors. Several years ago, when lenders offered interest-only lending as an option with no rate penalties, investors would naturally flock towards these structures. Why wouldn't you? It gave you extra cash flow so you could keep investing.
Unfortunately, APRA has since intervened and forced lenders to change their treatment of interest-only loans. This has changed the attractiveness of interest-only lending to the point where it may simply not be worth it any more.
There has been articles in the press lately about the possibility of mortgage brokers going out of their way to push clients into taking out bigger loans so that they get paid bigger commissions from lenders. I wanted to comment on this since, while is sounds like a good story, the practicalities of it are quite a bit more challenging and unlikely to occur.
Let me say up front - yes, mortgage brokers are paid by the lenders based on a % of the loan amount. This comes in the form of an upfront payment of around 0.6% and a trailing payment of around 0.15% per annum of the balance of the borrowings. This is a payment in return for the broker services which includes searching for the loan, talking to lenders, doing the loan application, talking to the assessors and working with conveyancers and sometimes accountants.
Now back to the theory that mortgage brokers go out of their way to jack up loan amounts.
Firstly - it is hard to do. Customers know what they want to buy, they know the buying costs, they know how much deposit they have saved. The math is pretty simple to work out how much they need to borrow. For a mortgage broker to say "Oh let's increase the borrowing amount by an extra $50,000" then they will get the customer response of "Why? I don't need any more". I don't know about you but I just can't see how you would be convinced to borrow more than you need.
Secondly - let's say the morgage broker was able to convince a client to get into debt by an extra $50,000 for no great reason, what would the broker stand to gain? They would get an extra 0.6% upfront, which in this case would be $300 and an extra $75/year in trailing commission.
Would any broker risk their credit representative status for the sake of an extra $375? I seriously doubt it and any that do don't deserve to be operating. Their licensee will be checking their loans regularly and a pattern will emerge fairly obviously if they consistently write loans where clients are borrowing more than they need.
A tip for dealing with a mortgage broker is to be on the lookout for any suggestion that you should be borrowing more than you really need. If you feel that they are overly pushy then it will pay to shop around for a new mortgage broker.
Getting the lowest rate home loan is something we all strive for when taking out a new loan. However, there are attributes of your loan requirements that determine what rates are available to you. Some things you can control and others you can't. At the end of the day, lenders will offer lower rates for lower risk loans. Let's explore some of the more common factors.
One of the biggest influences on what rate you can get is the loan-to-value ratio (LVR). Put simply, this is how much you are borrowing versus the value of the property that you are purchasing. LVRs of 60% can drive much better rates than LVR's of 95%. In essence, having more deposit (resulting in a lower LVR) means you usually get lower rates.
The purpose of the loan makes a big difference. Owner-occupier lending, where you intend to live in the property, will get much better rates than when you are borrowing as an investor.
Many lenders offer better rates for larger loan amounts. Typically loans over $750,000 will often open up improved rates. While lower loan amounts still command good rates, your ability to negotiate a lower rate improves with loan size.
Most lenders now charge more for interest-only loans so that they can limit the amount of investment lending as per APRA's requirements. Consequently, interest-only rates are typically 0.4% - 0.5% higher than principal+interest rates. Going with principal+interest will improve the rates on offer.
No-frills loans, those without features such as offset accounts, will often provide lower rates. Loans with monthly fees or larger application will also give you lower interest rares. Be careful here since the fees can add up quickly and make what looks like a great rate loan turn in to quite an expensive one.
Tier of Lender
The tier of lender can often impact rates. It is no secret that the big four tend to charge more, on average, for home loan rates since they have a lot more invested in bricks and mortar branches. Tier 2 lenders will usually offer lower rates. Being flexible on lenders can usually open up more attractive rate options.
Other factors that can improve the rates on offer include having the property located in a metropolitan area, being employed in a full time job with the same employer for more than 6 months and having genuine savings.
As you can see, it is quite complex and sometimes very confusing. A mortgage broker can help since they will compare the rates and fees of loans and will be able to assist you with finding the best product in the market based on your lending needs.
An offset account is like a regular savings account except that it is linked to your loan account and any balance in the offset account reduces your loan principal. This has the main benefit of reducing the interest you pay each month.
For example, take a home loan at a rate of 4.0% p.a. with a balance of $500,000 and you had an offset account linked to the home loan where you maintained a balance of $50,000. The $50,000 in the offset account would effectively reduce the balance by $50,000 on which the interest is calculated - saving a cool $2,000 a year in interest.
Another benefit of an offset is account is that you can withdraw funds from it at any time, giving you easy access to your savings.
The main downside to an offset account is that many lenders will charge a monthly or yearly fee to have the offset facility. However, if your savings on interest is high enough then it will pay for itself over the life of the loan.
If you have a home loan then consider putting all of your salary and savings into a linked offset account. It can save you plenty on interest and allow you to pay off your home loan much faster.
Talk to us if you would like to learn more on how to save on interest by refinancing to a home loan with an offset facility.
Buying a property can be quite an overwhelming experience, especially if you have never done it before.
Here are the steps in buying a house, unit or townhouse in QLD: