An investment property is a great way to help secure financial independence but are you receiving the maximum return on your investment? Exploring your funding options and structuring your loan for maximum tax benefits will help you achieve this. In this article I will examine both considerations.
Loan to Value Ratio
Get your loan approved to the maximum loan-to-valuation ratio that you possibly can and one that is most suitable for your needs. For example, Line of credit products are not suitable for investment properties - when you do a redraw on your line of credit, unless that redraw was totally related for expenditure on the investment property, you may have issues from a taxation point of view claiming the interest component on the redraw.
If you have owner-occupied debt the concept would be to park all of your income into the owner-occupied debt, as it is not tax-deductible. For investment property loans, make sure there is an offset account linked. If there is surplus income coming in, that income should be parked in the offset account totally separate to the loan account. As a result of doing this it will still offset the balance against your loan, but when you take out money from the offset account it is not regarded as a redraw on the loan so there is no muddying the waters when it comes to your account and doing your tax return.
Use Interest Only Loans
Also look at taking the interest only option. Interest-only repayments are generally the minimum payment required on an investment property loan and as a result of the principal component not being tax deductible from the payment portion, the only payment you should be making is interest only if you have other consumer debt and non tax-deductible debt.
You should also consider a feature offering the flexibility of paying your interest in advance. Some lenders will allow you to pay up to 13 months interest in advance. Doing this could solve some of your tax problems for that financial year.
Where there is rental income coming in and you have non deductible debt, you should be parking the rental income into the owner-occupied debt, and then out of that just getting minimum repayments coming out and paying the investment debt. By doing this you will pay off that home loan sooner and maximise your tax deductions on the investment property. A real win win situation.
Another feature to look at is portability. If going forward your aim is to accumulate a portfolio of several investment properties you might be in a position where you need to sell one property, someone might make you an offer you couldn’t refuse and substitute that for another property. Yet your financial position at the time might be favourable to apply for finance in the lenders eyes. So when you take out the loan, make sure it has the flexibility to be able to substitute securities so there is no need to go through the normal criteria of credit checks and providing updated proof of income. This could be a very low-cost and effective alternative to restructuring your finance.
Fees and Charges
Consider what ongoing fees and charges that banks charge are really costing you when working out the real comparative interest rate. Professional packs originated years ago for high net worth individuals with a certain income or loan amount. Some lenders are now calling loans professional packages, but what they are actually doing is charging you an annual fee of $395 per year for the privilege and adding that on top of your actual loan amount. The cost of this in years to come could offset some of the discounts given from a rate reduction point of view. So you need to determine if the annual fee with a rate reduction is still the best option for you in years to come when your balance is reduced.
Look at other associated fees attached to the loan. For example, monthly fees, redraw fees, account keeping fees, all of these add up to significant cost over the average loan.
Maximise your Cash Flow
When structuring the loan, if you have no other consumer debt, its still recommended you reduce the investment debt quicker, therefore creating more equity a lot sooner and being able to duplicate your wealth creation strategy of buying more properties.
One way to do this is maximise your cash flow. Instead of waiting to get your tax cheque back at the end of the financial year, you could submit a variation to the tax department ie. instead of cash flow going to the tax office coffers until you do your tax return and get your tax cheque back, you can put the projection in today and park the cash flow benefits into an offset account, linked to your loan which effectively saves interest on the loan. As the property increases in value, your loan also reduces much quicker and gives you expenses equity much sooner.
Fixing your Loan
When investing for piece of mind, consider a fixed rate loan. Some lenders, when working out your borrowing capacity on a variable rate loan, add loadings onto the variable rate component. This is generally in the vicinity of about 1.5-2 % on top of the actual variable rate at the time. However, should you take out a fixed rate loan for a term greater than 3 years by locking in that rate, the lender will use the fixed rate as the assessment rate when working out your borrowing capacity. This could increase your borrowing capacity by over a six figure sum and in doing so you can actually buy a property of greater value in a better area and going forward you should have better capital growth on that particular property. It is not unusual to be able to see a six figure discrepancy of borrowing capacity between one lender and another because of the way the loan is structured and the way your borrowing capacity is assessed by different lenders.
Pro-investment loans use 80% of the rental income or even higher but some lenders will reduce this figure to 60 or 50%, where others won’t even take rental income into consideration. This should be factored when borrowing money. You need to go to a lender who actually understands and has an appetite for investment property loans and doesn’t just treat them as a standard variable rate home loan.
Avoid Lender Cross-securitisation
If you have more than one property, generally speaking the lender would like to cross-securitise that with your other properties. If you allow a lender to do this it could restrict you going forward. If you decide to sell one of those properties the lender could take the difference of that sale and mortgage on settlement and park that into your other loan. This reduces the lenders exposure but it can reduce your tax-deductibility from the particular loan and might not be your best option.
The idea is never to cross-securitise, always keep each property as a stand alone. This may cost a little more in preparing separate mortgage documents but for a few hundred extra dollars it is a cheap insurance for you being in control of your investment strategy and not the lender.
Deal with a specialist, such as a mortgage manager. When all you do is mortgages, you get very good at it. One that has access to knowing what the investment property valuation came in at. The benefit of this is that you will know the real value of the investment property. In some cases lenders don’t disclose the value of each property but cross-securitise that with your owner-occupied property. By doing that they are actually protecting themselves. Keep the loan stand-alone and try to be advised of what the independent valuation came in at for each property.
Repairs and deductions
Another thing to consider is the cost of repairs, replacements and improvements which could be assessed differently from a tax deductible point of view. Say, for example you have a leaky roof, and decide to replace it with another type of roof covering. That roof covering may be classed as an improvement if it is not the same as the original and therefore not considered to be 100% tax deductible in that particular year, the borrower instead having to ammortise the cost over a period of time. A colourbond roof replaced with a tiled roof is good illustration of what I’m talking about- you can potentially miss out on thousands in your tax refund for that year because this could be considered as a improvement not a repair.
Take out Insurance
Ensure your property manager is experienced and understands the proper process of selecting tenants. Consider taking out two types of insurance. Landlord insurance is tax deductible and protects you from bad tenants. The other is loan repayment insurance, which can also be linked to your loan. This covers you in the event of sickness, accident and unemployment. The income protection component of this insurance is tax-deductible.
Try to select a property manager that has the capacity and flexibility to pay your rent and bills as they are received. The sooner you have this money parked in your loan account the sooner it is working for you.
An investment loan without review periods is desirable. Review periods may require you to prove your income periodically. This may be inconvenient for many people or you may not want to be in a position of having your credit checked or supplying proof of income on a regular basis.
Sit down with a specialist and review products on a regular basis because many come onto the market that are investor-focused and could be a good fit for you. For example, there are products that allow you to borrow against the value of your owner-occupied property, up to 20%interest-free. You can then use this money for any worthwhile purpose. This can still be done without cross securitising and keeping both properties separate.
If you want to refinance your investment property, do your homework. When refinancing, a valuation is normally required and a valuer will put a figure on your property’s worth. Sometimes by supplying data on comparable sales which the valuer may be unaware of, it can potentially get you a better value on your property. A better value means you can borrow more against it and by leveraging more against that property, you can use those funds to continue your wealth creation strategy and potentially buy more property.
The secret to investing in property, including negative gearing, tax deduction, leveraging and accumulation of many properties where the ultimate gain is capital growth. Your profit is normally built up over time with a combination of the right property just as importantly, if not more importantly the right loan structure.
This is general information only. For specific advise speak to a specialist who will consider your individual needs.