Your Investment Property spoke to prolific property investor - Sam Saggers to find out his top finance tips to help you reduce your costs and minimise your risks.
1. Change over from a principal and interest to an interest-only loan
When building up their property investment portfolio, a lot of investors make the mistake of taking out a principal and interest loan.
I say “mistake” because this kind of loan can put a stop to your investing career before it’s even off the ground. When you’re building up your portfolio you want to gain as much equity as possible – equity which you will then draw from your properties and use to buy more investment properties.
How many investment properties do you need? In today’s market it takes about six to become financially independent. Although it’s great to pay off debt, you don’t want to stop at one or two. That’s why an interest only loan is the best loan type at this time. Once you have reached your goals and begin to consolidate your portfolio, you can choose to switch to a
principal and interest loan and begin paying down your debt.
2. Put compound interest to work for you by using an offset account.
An offset account is simply an interest-bearing savings account, which is tied to your loan account. The difference between a regular savings account and an offset
account is that the balance in your mortgage-offset account is “offset” against the balance of the mortgage.
Let’s say you have a $100,000 mortgage and an offset account with $10,000 in it. The interest you would pay on that mortgage will be calculated against $90,000 - not $100,000. Using the current average variable rate of 6%:
Without using offset:
$100,000x6%= $6,000 interest payment per annum
With $10,000 in the offset account:
$100,000-$10,000= $90,000x6%= $5,400
Savings: $400 pa
As you can see, the more cash you keep in your offset account, the higher your savings on interest will be. Any “notional” interest on savings is earned at the same rate as the linked loan. Over time the savings - which you can certainly add to at any time - can help pay down the principal or build up your equity.
3. File a PAYG variation to reduce your tax
Rather than letting the Australian Taxation (ATO) keep your monies, file a PAYG variation to reduce your tax bill and use your cash during the year. It’s your money after all, so
why shouldn’t you have access to it sooner?
When you file a PAYG variation you'll receive your refund on a regular basis - with ever pay packet-rather than one time at the end of the financial year.
Use the increased cash flow to pay down a bad debt, add towards an investment property deposit, add to your buffers, go on a holiday - whatever you choose.
The PAYG variation doesn't take the place of your annual tax return. Obviously, you will still need to lodge a return as usual; the payments you receive throughout the year will b credited against your tax obligations.
Note that variations expire June 30 of each year so best practice is to submit a new application by May or early June each financial year. Don't forget that if you change employers you will need to file a new variation request.
4. Use different lenders for each property to avoid cross-collateralising your assets
Cross-collateralising your loans is not recommended, as it will put a major roadblock to building
your property investment portfolio.
For example, if you own a property that you wish to sell and it is cross collateralised with other
loans, your lender may insist that you use the monies from the sale to pay down your loans so
that your portfolio is kept at a certain LVR.
5. Create good buffers with your properties
- The lender can limit your borrowing options, such as only offering a principal & interest instead of an interest-only loan, citing exposure limits as their reason.
- Fees - including exit fees for fixed loans - can be significant, making it very costly and difficult to change lenders.
- Your properties are valued as one asset, so if you have one property which fails to perform it negates the capital growth of your other properties.
- To avoid the risk of cross-collateralisation, choose different lenders for each of your loans.
- Be aware that even if you have sole and separate loans with one lender, many load documents have what's known as an “all monies” or “all securities” clause which has the same effect as cross-collaterisation.
With each and every investment property, set up a buffer account to cover two to three years worth of property costs.
Ideally, it will be linked to your loan as an offset account so
that it can earn interest.
Start wherever you can. If you don't have two to three years worth of capital, put as much as you can into your offset account and begin adding as much as possible to the account.
Once you have accumulated enough equity to cover the costs, refinance the property and stash a sizeable portion into your buffers - spreading it out among various properties if needed.
Boost your savings even more by living off a credit card with at least a 45-day grace period. Put your entire pay packet into the account – where it will accumulate interest – and then pay your credit card off to avoid any interest charges.
6. Always double any quote you’re given, whether for time or money
This is almost goes without saying, but whenever you're quoted a figure, double it. For example, if you're told that it will take three months and $20,000 for a development approval, double both the time and the money to avoid finance and scheduling issues.
Although it's nice to be pleasantly surprised and good to be optimistic, it's smart to be realistic as well!
7. Organise a depreciation schedule to increase your tax deductions
As investors we want to take advantage of every cost saving device available to us, and depreciation is a good one.
A depreciation schedule works by reducing your taxable income. Fees can vary greatly so shop around for the best deal.
Depreciation is compensation for the general wear and tear of your investment property. Investing in property is a business. There are two types of depreciation: capital works, and plant and equipment.
Capital works involves the structure itself as well as items that are permanent (eg door and window fittings, the driveway or built-in cupboards).
Plant and equipment are items that can be removed (eg carpets, blinds or air conditioning units).
A common misconception is that your property has to be new to get depreciation. While your depreciation will be greatest on a new property, older properties still have some depreciation left in them, so don’t discount the possibility of depreciation offhand.
If your property was built after July 1985, you can claim both types of depreciation; however, if it was constructed earlier you can only claim on plant and equipment. Still, it’s worth the effort. After all, even the fees for the schedule preparation are tax deductible!
8. Pair loan to value ratio (LVR) with density type
If you want to obtain a loan at 95% LVR, a good rule of thumb is to choose properties that are low-density type properties.
If, however, you want to go with high-density properties, go for 80% where possible. You can run into issues with valuations if you go up to 90% with these type of properties.
Should this happen, re-submit your loan application, find another valuer or lower the LVR by investing more of your own capital