Finance Q&A: Finance Structure and Interest-Only Loans

13/01/2014

Our resident finance experts answer readers’ questions on how to set up a finance structure to make borrowing easy in the future, and on whether to stick with interest-only loans

Finance Structure

Question: I’m a first home buyer thinking of upgrading or buying multiple properties in the near future. What do I need to put in place structure-wise to ensure I can borrow easily in the future?

Answer: It is too early in your investing career to be looking at trust structures at this stage – perhaps later. My best advice is to have a good, steady income and no debts outside of property, ie no credit cards, car loans or interest-free loans, and buy as soon as you can. Time in the market is hugely important to property investing.

As for structures, if your goal is multiple properties, then buy one to live in first and ideally this should be your smallest debt. Then once that property is reno’d and settled in, use the equity in this property to buy the next one.

The best way to do that is to ask your bank to revalue the property, and then establish a line of credit against the created equity of up to 80% of the valuation (or 90% of the valuation if you are happy to pay mortgage insurance).

Keep all your loans flexible: you will never know if and when you will need to change banks, so a variable or a one-year fixed loan will mean you have the ability to change banks for one or all of the loans you may need.

Property selection is also critical. Buying the wrong property will mean many years before you can buy the next property. Set a goal of never letting three years go by without buying a property.

– Catherine Lezer

Interest-Only Loans

Question: My husband and I are in the market to purchase our first investment property (while renting at our current residence). We have quite a substantial deposit towards our interest-only home loan and are wondering how much we should put towards this home loan and whether we should ‘keep’, say, $100k of that deposit in order to purchase a second property.

Answer: Starting out on your investment journey is as exciting as it is daunting. There is so much information out there and often a lot of conflicting views making it harder for you to make the first move a right move.

There are a couple of things you are seeking guidance on in your question – firstly, the concept of interest-only loans when you don’t have a current loan against a principal place of residence. Most people might think it’s best to have a principal and interest loan option if this is your only debt. I take the view that you are best served by having an interest-only loan instead, so long as you have an offset account linked to it. This way you get the best of both worlds: you are not paying any additional interest you shouldn’t be, but you also have the option to then use these funds out of the offset account to set down as a deposit on a principal home when you do finally make that decision.

In terms of what amount of deposit you pay, how much you hold back, and whether to buy two properties instead of one, well, there isn’t a simple and straightforward way to answer this; your personal circumstances will dictate your decision as your current and future cash flow, along with any plans that will have an impact on that cash flow, will determine the solution to this puzzle.

The best way to illustrate what I mean is to give two examples of two very different circumstances producing two very different outcomes.

In my first example, let’s say you want to start a family in a year or two. This would usually result in having to rely on just one income, plus the initial costs of having a baby, plus the inevitable discussion around buying your own place. So what if you don’t have enough money and cash flow to do it all and you are forced to sell a property? Usually, once you add up the buying costs to secure it, the holding costs, and finally the selling costs, you have more often than not lost money.

In the second example, let’s say you do have the savings and cash flow and you don’t foresee any large cash flow impact that will force you to sell in the next 10 years. This means you could be in a position to buy two investment properties and at a 90% LVR (loan-to-value ratio), as opposed to buying one property at an 80% or lower LVR. All other things being equal, this will provide you with a greater return and wealth base than just buying one property, because you are controlling a larger asset base that is compounding in value over time and provides you with two income streams.

The answer is going to be in forward forecasting your savings and cash flow against your life plans. If you plan this well, then you will make the right decision for you.

– Ben Kingsley