There is a lot more to sourcing and managing the finance around your investment property purchase than simply telling your bank how much deposit you’ve got, what security you are offering and getting a loan ‘off the shelf’. In fact, there are many aspects to financing that your bank may not necessarily tell you about.
The following are some of the hidden truths your lender is unlikely to tell you about, according to Chris Acret:
1. There may be better product options – either with that bank or another lender
Often there will be a better product available which is more suited to your needs – either with that same lender, or with many other lenders.
Obviously a lender is not keen to point this out – it could mean more work for them or that you will move to another lender.
Remember, lenders are generally looking at the transaction from their perspective, rather than yours.
That is why mortgage advisers or brokers play such an important role; their focus is on working with and for you to understand your investment goals and find products and develop structures that will help you to achieve these.
2. There are ways to avoid LMI (Lenders Mortgage Insurance) – if you want to
The bank will tell you that if you borrow more than 80% of the property’s value, then you need to pay LMI.
What they may not tell you is that structuring the loan a certain way, or using something like a family guarantee, could avoid or significantly reduce what can often be a major cost.
LMI premiums – which protect the bank in the event that you default, but not you – can differ significantly between lenders. Therefore, it’s unlikely that your lender will tell you that you a competitor may charge premiums that are only half of what they are charging.
Having said that, some investors may be quite happy to pay LMI because it means they take less equity out of their home or it gives them the scope to buy multiple properties – they can buy two investment properties with a 10% deposit rather than one with a 20% deposit.
3. A line of credit can be used as a ‘working account’ to help manage your investment property’s cash flow
Say there is a $500 a month gap between the income your investment property is earning and the expenses that you incur – that is a significant amount of money for people to personally fund every month.
With the approval of your accountant, you could consider using equity in another property to establish a line of credit as a ‘working account’.
For example, if you were to establish a line of credit of, say, $20,000, all the property’s income and expenses can be run through the account (providing a neat summary of all) and the $500 monthly shortfall is funded from the $20,000.
The investor has the option to only fund the interest on the line of credit at a minimum, which in this example would be only about $27 a month and is also tax deductible.
The bank may not necessarily put forward customised arrangements like this to you, preferring to offer a standard ‘off the shelf’ product structure, rather than build a tailored structure to suit you.
Just keep in mind that the downside to this strategy is that you are eating up some of the equity in your own property, so you need to be confident that your investment property will have good capital growth.
4. Initial loan structuring is critical if you plan to make your owner-occupier home an investment property in the future
If this is your longer-term plan, this needs to be considered and factored into your loan structure from the outset to ensure that the property can be turned into an investment property down the track.
As part of this strategy, you would generally look to put in only the minimum necessary deposit initially, keeping the remaining funds in an offset account, maximising the debt and minimising the interest payments that need to be made while it is an owner-occupier property.
However, your bank may be keen for you to put the maximum deposit in from the outset and may not be proactive in providing advice on how to manage the loan so it is easily turned into an investment loan in the future.
The aim is to pay minimal interest while you are living in the property, because there are no tax deductions during that time, but at the same time keeping your options open.
When you turn it into an investment property it still has a high level of debt on it for tax effectiveness and you have access to every available dollar in the offset account for the deposit on your new owner-occupier property.
5. Avoid cross-collaterisation as much as possible but if you do need to, avoid putting the family home up as primary security
Most lenders will probably tell you that cross-collaterisation is required and a necessity if the loan is to be approved, as this provides the greatest security for the bank.
However, what they are not telling you is that with the right loan product and structure, this may not necessarily be the case and the properties may be able to be kept ‘stand alone’.
By having the properties ‘stand alone’ it provides a greater level of asset protection if something were to happen to the investment property or if it were to drastically fall in value.
For some lenders it is standard practice to put the property with the highest value (generally the family home) as the primary security. If you do need to cross-collaterise, use the family home as secondary security, not primary security.
6. Selecting a basic loan or a professional package should be determined by your investing plans
Basic loans are ‘no frills’ products that generally offer a lower interest rate with no or low monthly fees attached plus an application fee.
In comparison, professional packages are a way of packaging a loan with extra benefits such as discounted interest rates and lower fees but generally have an annual fee attached (but no application fee).
Your lender may actually be keen for you to take up the professional package because it often allows them to sell a number of products at once – perhaps a credit card and a transaction account as well as the home loan. If the professional package meets your needs – perhaps because you are looking to acquire multiple properties – then that’s great.
However, someone looking to have their family home and, say, just one investment property may well be better off with a couple of basic loans.
7. Fixed rate break costs will apply and could be very costly
Working out the costs on breaking out of a fixed loan at some stage in the future is almost impossible.
Your lender will probably tell you that there are costs associated with breaking out of a fixed loan and will show you a very complex formula for working out what this is, but they won’t be able to tell you how much these are – or that they could be incredibly high.
The final cost is determined by the rate you fixed at, the bank’s current cost of funds, the term you fixed for, and the amount you borrowed. However, the general rule is that the bigger the gap between the rate your borrowed at and the prevailing rate when you go to break, the larger the break costs.
And they can apply regardless of why you need to break the fixed rate, such as selling the property, so if you do choose a fixed rate you need to be pretty certain that you are unlikely to need to break early.
Chris Acret is Managing Director of Smartline Personal Mortgage Advisers. For more information visit: www.smartline.com.au