10/06/2013
Your Investment Property’s resident finance expert Andrew Krauksts answers a reader’s question on whether it’s better to borrow related buying costs or use your own money, and whether you should avoid LMI altogether
Q: When buying an investment property is it better to borrow all related costs, eg stamp duty etc. or should you try and use your own money? Is it better to pay LMI so you can continue investing and claim it as a tax deduction, or pay off your loan to avoid paying it?
How can I keep buying properties if I have my own house with mortgage $265,000 valued at $450,000 and two investment properties. Should I spend some money on a property to increase the value to keep the LVR below 80%?
And when going to the banks to get more loans should I have the houses valued or will the banks just do their own?
A: When purchasing an investment property the only cost that can be added to your investment loan (within reason) is the lenders mortgage insurance (LMI). Other costs,eg stamp duty, legal, valuation, lender application etc cannot be added to the loan, unless funds are borrowed through accessing equity inanother property.
The preferred strategy for many investors, if they have the available equity, is to borrow the entire amount. For example, if you are considering buying a $500,000 investment property you may borrow $450,000 secured against that property (in some instances up to $475,000 – 95% lend). And, at the same time borrow around $75,000 against another property to use for the deposit and closing costs,eg stamp duty etc. These structures also keep the properties separate and stand alone for better flexibility and protection.
TIP: Lenders will allow you to extract equity up to 90% of the value of your property, and purchase an investment property with a loan to value ratio as high as 95% (in other words by using a deposit which is only 5% of the purchase price).
Whether you should use your own money or not comes down to a number of factors. For example, do you have a home loan? If so,your cash reserves may be better placed in an offset account to pay less interest. If you have a large amount of cash, depending on your strategy,it may be better to use cash and only borrow 80% to purchase an investment property. The reason why so many people advocate using loans to fund everything is because it allows, within reason, to buy more investment properties, tax deductions etc. Many people have limited cash resources and as a result use their equity to buy more properties. Overall though the answer to this question depends on individual circumstances (cash available) and strategy (how many properties you wish to acquire etc). So careful planning is a must to get the right answer.
TIP: If your plan is to buy multiple properties with limited cash/equity available, and as long as you have done a risk management plan (eg assessed holding costs, impact of rate rises, tenant vacancy etc and how you will manage that risk) then using equity or minimal cash along with borrowing most of the funds for investment is a great strategy as it may allow you to purchase multiple properties to create wealth faster.
Pros: Minimal cash input, great leverage, higher tax deduction, ability to buy more properties
Cons: Bigger holding costs, greater risk if property drops in value, LMI fees
Pay LMI or not
From the information you provided it appears you have $140,000 in useable equity from your home (since the lender will only allow you to gear your home up to 90% of its value). I am assuming your other two investment properties are stand alone and not secured against your home.
Paying LMI in many ways can be viewed as an opportunity cost. Meaning, if your cash resources or equity are limited or you are trying to buy multiple properties over time you need to protect your cash/equity to leverage it further. As such, paying LMI (which most property investor know is tax deductible) can be a good thing as it allows you to stretch your dollar further and apply the principle of leverage.
This is one of the attractive features of property investing. For every $1 invested the banks may lend you $9. In other words if you buy a property for $100,000 the lender may lend you $90,000. Many believe it is worthwhile paying the LMI if they can hold a bigger portfolio that creates wealth faster by holding multiple properties. Reason is, if you hold one property at $500,000 whichgrows by 6%,you’ve made $30,000. But if you pay the LMI it may allow you to buy two properties which now creates a $60,000 gain over the same time. Double the amount in wealth creation in the same time– the power of leverage.
TIP: Always keep your properties and loans stand alone (not cross secured). Besides many other advantages beyond this article, it will keep your LMI costs down by possibly thousands of dollars.
Adding value to keep LVR low
There is no need to spend any money to value your own home. You will find that arranging your own valuation will not be accepted by the lender. They use their own panel of valuers and in many cases valuations are on the conservative side. Lenders want to know what the minimum amount of money is they can get for your property in case of a fire sale.
TIP: If valuation is a concern for you, many lenders will allow an upfront valuation, arranged by their panel, prior to an application being placed with them to ensure you know your outcome.
Ultimately though, all these factors are determined through individual strategy. It is of utmost importance that you devise a plan/strategy first. If you know your desired outcome it is much easier to determine whether to use cash, equity, pay LMI and how much an investment property should be leveraged to. Write out the end game, devise a plan, apply risk management – what if, and then ultimately... take action.
