16/08/2012

Question: My partner and I want to enter the investment market with plans to grow a portfolio of four or five properties. We want to start investing soon, but a recent failed business venture has left us with $40,000 in credit card debt. Does this make it a bad idea for us to enter the property market right now? 

We understand that our debt is substantial, but we’re not a hopeless case. We have the benefit of paying little in rent and have secure employment through the Defence Force. We also recognise that reducing the credit card debt prior to seeking property finance would seem the obvious thing to do, but we’re concerned that it will be a long, slow process. 

We’re thinking that purchasing high growth property now could allow us the option of refinancing later to consolidate the credit card debt. Is this a good strategy? Or, should we rather hold off for another 12 months and focus on reducing the debt? 

Answer: Your credit card debt is unfortunate though not a major problem. The main disadvantage is not the size of the debt but the impact it will have on your borrowing capacity. Credit card limits, even if unused, can reduce the amount you can borrow because they represent a possible future expense.

In real terms, the credit card represents a drain on your cash flow. Credit cards have high interest rates and, used as long term loans, they are a disaster. 

Investing in property is a great idea.  Any upward movement in the property market provides you with an increase to your equity position and, depending on your available income, refinancing to consolidate the credit card debt is certainly feasible.  Naturally, this increase in equity may take some time to achieve so you will need to be able to manage the credit card payments as well.  Income is the key here. It’s important that you are able to manage the debt until you are able to consolidate.

Remember, using the equity growth will only transfer the debt from the credit card to a loan secured by the investment property. The debt itself is not being repaid. Of course the lower interest rate will benefit your cash flow position; however, it is important to realise the debt is the issue, not the interest rate.  I recommend you get a separate loan when you have enough equity in the property so you can keep the two debts separate for tax purposes. Your Accountant will thank you come tax time. The debt will not be a part of your investment property gearing as it was created from a different purpose.

One way to get rid of the business debt, obviously, is to repay it. Increased equity does not repay the debt. You have to see the increased equity outside of the property.  That could mean selling the property to realise the profit. 

This might seem like the opposite of what you want, but understand that investing is not necessarily the accumulation of property. Investing is about making money. Buying property, creating equity and selling for a profit can be a sound method to make money. It’s this money that will reduce and eliminate the business debt.  

  • Answer provided by Vincent Power, Investors Direct (investorsdirect.com.au)