12/06/2014
One of the great advantages of residential property as an asset class is that you can gear it much more highly than any other asset class. Banks simply won’t lend you 90% against shares and bonds, much less works of art or cases of wine.
Gearing (borrowing money to buy an asset) amplifies capital gains and (as we were so rudely reminded by the recent GFC) it amplifies losses too. A lot of the general advice that follows in this article is about ensuring that you don’t get caught out by the finance you arrange to buy investment property; that is, you don’t become a forced seller and risk taking a loss.
The Power of leverage
Since property is probably the only asset class that a lender will lend up to 95% of its value shows you that lenders consider the asset less risky than other forms of investments like shares etc.
Depending on your risk profile you can accelerate your property portfolio through leveraging - by putting less of your own money into the deposit and using more of the bank’s. This can have its advantages and disadvantages.
Anything less than a 20% deposit, the banks will mortgage insure the loan. The cost of this premium will be passed on to the borrower… AKA you! It doesn’t protect you but it protects the bank if there is a shortfall, assuming they had to mortgagee-sale the property and they sold it for less than what you owe. The insurance company pays this to the bank so they are ok, but the insurance company will also come to you to recoup their losses- pretty savage stuff.
The (one off) premiums on these policies have increased dramatically over the last few years – not due to a poor claims experience in Australia so much as that in the subprime USA, where much of our LMI is underwritten. Not fair, but that’s the global economy for you.
So LMI has become astronomically expensive and its cost is added to your loan when you purchase. The bigger your loan, the greater the premium rate (as a percentage of the loan) and the higher your loan to valuation ratio (LVR), obviously the greater the premium rate too. The mortgage insurers also can make the assessment of the loan more stressful and difficult; because they are ultimately the ones at risk to lose money they will have stricter policy when assessing a loan.
The Importance Of A Cash Buffer.
The upside to using mortgage insurance and putting less of a deposit down, is that it enables you to do a number of things. One, you can keep more of a buffer back and this is essential for property investing. It sounds ironic that it’s actually safer to borrow more and get into more debt. But this way, you have funds as a back up to cover any rough patches (like no tenants, unexpected maintenance etc.) Having the buffer buys you time to weather a storm with your property investment. You can also claim the cost of the insurance through your tax. Consider the risks you are exposed to if you put all of your funds available in as a deposit and leave nothing as your buffer: If something happens you have no back up.
The other thing is that by putting less money into one property purchase you may have enough funds to purchase another property. This will grow your portfolio faster as you will be building up the base for more capital growth and/or balance your cash flows by purchasing one positive cash flow property and one negative geared property.
So when looking at your finance strategy, consider the loan to value ratios and the costs of lenders mortgage insurance vs. your risk profile to debt and long term goals.
Would you like to learn more from us? Securing the best finance for your investments is always a key element to building a successful portfolio geared towards creating your wealth. If you’re looking to get started in the market or to keep building on top of your current investments, grab our eBook (it’s FREE) “What Every Investor Must Know Before You Choose a Lender” right here.
Michelle Coleman is a first-rate mortgage strategist and mum, and she heads up the team at W Financial. She is without a doubt, a legend of the Australian mortgage broking industry, having achieved over $500M of settlements in her 12+ year career to date, and won numerous industry awards, including #3 MPA Top Broker. Michelle is also a highly experienced property investor. www.wfinancial.com.au
To see the rest of this series and to read more Expert Advice articles by Michelle, click here
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.
