(Plus Loan Structuring Hacks New Investors Must Know)
Owning one or more investment properties is a significant achievement. Property investors leverage one of Australia’s most popular, and often most effective, ways to grow wealth. However, ascending from home ownership to investment property ownership (or even buying an investment property as your first step up the ladder) isn’t as easy as it might seem. Many people fall short on the very first step: generating a deposit.
To make it even more challenging, in most cases, an investment property requires at least 20% deposit of the purchase price at a minimum… and with rising house prices (and mortgage interest rates), this is problematic for many.
However, with the right mix of strategy and financial discipline, saving a deposit for an investment property is more achievable than you might think. Let’s explore three practical ways to gather your deposit, and a handful of loan structuring tips that’ll make your wealth creation faster and even more effective.
1) Use Savings and Debt Recycling
A good ol’ saving regimen is a tried-and-tested approach to assembling your deposit. This is done by consistently setting aside a portion of your regular income, and leaving it completely untouched until you’re ready to purchase your property. We advise many of our clients to ‘mentally brickwall’ their savings account… making it ‘mentally untouchable’ until it’s needed for the purpose it was created for.
Implementing a debt recycling strategy can also enhance this process. In simple terms, debt recycling occors whereby the income generated from your investments is used to pay down non-tax-deductible debt, such as a home mortgage, and simultaneously reborrowing for investment purposes.
If you’d like more information about debt recycling, please contact us.
2) Use Equity
Leveraging the equity from a property you already own can be a powerful springboard into property investment. In other words, equity, the difference between your property’s value and the debt owed on it, can be used as security for your investment property’s deposit. This method allows you to tap into your existing asset’s value without the immediate need for cash savings.
However, it’s important to approach this strategy with a clear understanding and careful planning to avoid the pitfalls of poor loan structuring, which could lead to financial strain or reduced flexibility.
3) Use Gifted Money
Gifted funds, whether from family, friends, or as an inheritance, is often a source of funds for a deposit. However, lenders typically require a clear trail of the funds and may need evidence of your financial discipline.
Securing your deposit is just the beginning. Structuring your investment property loan (or loans) correctly is important if you want to maximise the potential of your investment and maintain financial flexibility for future growth.
Poor loan structuring could place a handbrake on future portfolio growth, because you may not be able to borrow more money.
Here are some tips for loan structuring:
Solution 1: Debt Segmentation
Distinguishing between your investment and residential debts is important for two reasons.
The first is for tax purposes. By isolating the loan for your investment property, you can streamline your tax deductions, as the interest on this loan is generally deductible. Please note, this isn’t tax advice. Speak to your accountant or tax advisor if you’d like more information about this.
The second reason is for cross-collateralisation purposes. Although these loans may be separate, it may be possible to secure them against the same asset, potentially sidestepping the need for Lenders Mortgage Insurance and possibly securing a more favourable interest rate based on the combined Loan to Value Ratio.
Solution 2: Loan Term Optimisation
The duration of your loan impacts your monthly repayments and the total interest accrued. A shorter loan term equates to higher monthly payments but less interest in the long run.
Conversely, extending your loan term lessens your monthly financial burden but increases the total interest paid. This trade-off requires careful consideration, especially in scenarios where maintaining liquidity is a priority.
Solution 3: Choosing the Right Payment Type
The structure of your mortgage payments, whether principal and interest or interest-only, can significantly influence your financial journey. Principal and interest payments chip away at both your interest and the principal, building equity but initially demanding higher repayments.
Interest-only payments, while lowering your outlay during the term and offering potential tax deductions for investors, don’t reduce the principal, possibly leading to a higher overall loan cost.
Solution 4: Interest Rate Structure
The choice between fixed, variable, or split rate loans can shape your financial flexibility and the total cost of your loan. Fixed-rate loans offer predictability, locking in your repayments but often at the cost of flexibility.
Variable-rate loans, although subject to market fluctuations, offer greater flexibility and features like offset accounts.
A split rate loan combines these benefits, providing both security against rate hikes and the flexibility to make additional repayments.
Solution 5: Deposit vs Equity and the Perils of Cross-Collateralisation
The decision to use a cash deposit or leverage existing equity is also important. A larger deposit can shrink your loan size and potentially avoid Lenders Mortgage Insurance, but saving it can delay your investment.
Using equity from an existing property can fast-track your investment but increases your overall debt.
It’s also important to be mindful of sub-optimal cross-collateralisation; if done incorrectly, linking multiple properties with a lender can complicate your portfolio and potentially inhibit future borrowing.
Solution 6: The Power of an Offset Account
Incorporating an offset account into your loan structure can lead to substantial interest savings. By offsetting your loan balance against the funds in this account, you’re only charged interest on the net balance.
This setup not only provides significant interest savings but also offers the flexibility and liquidity of having accessible funds without incurring taxable income, as would be the case with traditional savings interest.
In this quick phone call with a Virtus mortgage broker, we’ll quickly evaluate your options and give you a better understanding of your ability to save a deposit, and of course make the step into investment property ownership. Or, if you’re already an investor, we’ll see how we can help you purchase your next property (and beyond).
In summary, our free credit assessment helps you:
Unlike some banks (where you often meet with a junior employee), and some other brokers (where you meet with a commission salesperson), your free credit assessment at Virtus is with a lending specialist who will give you expert, independent advice specific to your situation.
Don’t delay anymore. A quick phone call with us could be a game changer.
When buying a property in Australia, it is important to consider the cost of any necessary renovations to cover any unexpected expenses.