How to nab the ideal loan: flexibility, control and more cash in your pocket
As a property investor, your job is heavily layered.
Not only do you need to be an expert researcher, forecaster, risk taker, money manager and real estate agent, you also need to be a shrewd asset manager.
While there are the traditional ways of making money as a property investor – such as aiming for capital growth, or benefiting from positive gearing – there are also some more strategic ways to stretch your investment dollars further, such as through optimising your loan structure.
It is these creative, strategic money-makers that I want to talk to you about today.
As a property investor, you can’t avoid the fact that, at least in the beginning, you will rely heavily on a lender to jumpstart your portfolio and to maintain it over a long period. But that doesn’t mean you have to put yourself completely at the mercy of your bank or lender.
It pays to understand exactly what types of loans are best for investors and how to structure them, to serve your needs and maximise your financial reward.
Here are five top tips for staying in control of your money and maintaining the flexibility you need to grow your portfolio.
- Avoid cross-collateralisation
This is a fancy way of saying, you need to keep your investments as separate from each other as possible.
If you use multiple properties as the security for one loan at one bank, you could end up with a tangled mess of mortgages that are linked together and prevent you growing your portfolio in a number of ways.
Firstly, you could have trouble accessing profits if you sell.
This is because the lender will insist that profits are used to service other connected loans, before you can touch it for your own purposes.
For instance, if your overall LVR is 80%, but selling one property changes this ratio to 83%, you will be required to pay down your other loans until they reach 80% – or be faced with a lenders mortgage insurance (LMI) premium.
This can be particularly problematic, if the reason you are selling a property in the first place is to access cash reserves, whether it is due to financial hardship or because you wish to fund future investments.
Secondly, it could affect your future borrowing power.
If you refinance a property that has been cross-collateralised (also known as cross-securitised), all of the properties connected to it will have to be revalued by the lender at the same time. If some of the properties have been underperforming, this may not work to your advantage at all and the bank may decline your request to borrow more money.
Thirdly, cross-collateralization means decreased flexibility.
It makes it very difficult to move one property in your portfolio to a different lender if you would like to refinance or change the loan structure.
Cross-collateralisation is usually preferred by the lender, because it means an extra measure of safety for them when partnering with you, giving them more control over your assets.
It doesn’t mean that you have to agree to do it their way, though.
Instead, create separate mortgages for different properties at different lenders – or even at the same lender if you have to. It will save you a world of headaches in the long run.
- Choose an interest-only loan
A key difference in a property that you own to live in and an investment property is all of the tax deductions available to you.
The interest on your investment loan is one major deduction available to you, which is why an interest-only loan is generally preferable for property invetsors.
These types of loans make sense, because paying off the principal is not tax deductible. Instead funds you would have used to pay down the principal can be redeployed to other, non-tax deductible debts, such as your own home.
Other benefits of an interest-only loan include the reduced financial commitment each month and increased flexibility, so you can channel your money where you need it most at the time, or take the pressure off when a tight period hits.
- Use an offset account
All investors need a financial buffer in the way of a line of credit or an offset account to weather the inevitable storms they’ll encounter.
Without a sufficient buffer, especially in more turbulent times, you’re at risk from things such as interest rate hikes, extended vacancy periods, stock market dips, illness or the loss of your job.
- Limit your reliance on the bank
The less deposit you put down and the more you borrow against your investment the higher your Loan to Value Ratio (LVR).
While gearing makes your money work harder when property values rise, having a high LVR accentuates your losses in a flat or falling market.
Beginning investors often have to borrow as much as they can to get into the market, but I’ve found keeping your LVR’s to 80% or less tends to be prudent and gives you a built in buffer in those years the market languishes.
Keep in mind that when you borrow more than 80% of the value of your property, you have to pay Lender’s Mortgage Insurance (which protects the bank – not you) or offer the security of another property.
Instead, maintain as much control of your own assets as possible.
Keeping your equity at or around 20% of your portfolio’s value will ensure you can get a competitive rate without relying on the bank too heavily.
- Spread the love
You know the saying, ‘Don’t put all your eggs in one basket’?
Well, it is also a good rule of thumb for real estate. Using the same lender for all your loans can put too much control in the bank’s hands.
For a start, they might know a lot more about you than you’d like and choose to use that against you if you are trying to refinance or extend a loan.
Secondly, if a bank knows they already have all of your business, they seem to think they won’t have to work as hard to keep you, and that could mean you end up stuck with loan structures that are no longer competitive or suit your purposes.
At the end of the day, it helps to keep things in perspective by remembering that banks and investors rely on each other to stay in business.
It is very easy to see what the bank gets out of the relationship when you pay that interest bill on time every month, but what about you?
Don’t settle for the short end of the stick in your relationship with your lender, and instead work towards loan structures that support your investing goals and deliver the greatest return on your money.
Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Update blog.