A wealthy businessman said to me many years ago “If all the money were thrown up into the world it would end up in the same pockets of those who have it now”!! Some people are just naturally better with money than others and some people just continually seem to waste money or make poor investment choices. HOWEVER being finance savvy is something that can be learnt or even done by using the expertise of others. With this, we discuss how to finance your property deals.
Have you ever noticed that wealthy people all seem to have investment properties? Often people make more money out of their properties than their day job or other business ventures.
I have worked in finance for 22 years and in my own case I earn my day to day spending/lifestyle income from my mortgage broking business, yet my wealth creation is done through property investments.
I love property because I can see it, touch it, visit it, change it and keep an eye on its value myself and its easy to understand. Shares for me are confusing and require careful study of the financial climate/shares climate which I just don’t have time for.
Property is actually solid and buying a property is very exciting. I spend very little time doing the paperwork or management of my properties. This makes property a passive income earner for me while I spend most of my working days in my mortgage broking business helping other people reach their property dreams, which I love!
Properties can be purchased in a variety of “entities”. Your own home is usually purchased in your personal name (as an individual or jointly with another person or other people) and this is referred to as a “natural person”, however once you enter into buying property for investment purposes some people may choose to use an alternative legal entity. Of course you would do this in consultation with appropriate advice from your legal, taxation and accounting experts.
Other entities available for financing investment properties are Self-Managed Superannuation Fund, Trust structures or companies.
The structure of your investment property finance is vital to the success of your over-all investment strategy. There are lots of reasons why the correct structure is important for your property investing including:
One of the benefits of an investment property is the tax benefits of having the investment. If you have gained the correct legal and accounting advice and the finances set up correctly you will maximise the tax, cash flow and capital growth benefits associated with the investment. For this reason interest only structured loans are often recommended for property investors.
Ease of the investment
If you have a complicated lending structure where you have to manually transfer funds here, there and everywhere with lots of accounts and varying loan splits it will turn your property investing into a full time job. Keeping it as simple as possible is the best way to invest.
There are two parts to asset protection. Firstly you don’t want to have your home or other assets tied up with your investment. It is fine to use your assets to get you started however you don’t want to put your entire asset or asset portfolio up as security for each investment. Your existing assets should only be used as a means for obtaining the deposit/funds to complete the purchase. e.g. If you have your own home you might borrow against the equity in that home for the deposit on another property but you only use your home for the deposit not the entire investment purchase.
You will want to ensure you have all the appropriate insurances in place to protect all your assets – this would include property or landlord insurance, life insurance income protection, trauma cover and so forth The last thing you want is to lose everything you have worked hard for because you need to take a few months of through illness or the like.
It’s important that you borrow responsibly and ensure you are not putting yourself into a position where you are going to have “no money or lifestyle” because you have an investment property. It is important that you work with your broker on this to ensure that they understand how much each month you are happy to contribute towards the holding costs of purchase (if anything)
What you need is a financial structure that runs on autopilot as much as that is possible and ticks away in the background while you get on with living your life
How much is needed for a deposit on an investment property?
The amount of deposit required for an investment property purchase varies quite a lot. The lenders change this policy depending on the amount of funds they want in or out the door at any given time and also depending on their view on the strength of the property market. The way you fund the deposit and purchase costs can also vary.
At the time of writing this article most financial institutions are doing loans for 95% of the purchase price of the investment property. When you are borrowing more than 80% of a property purchase price there is a fee called lenders mortgage insurance that needs to be paid. This insurance covers the lender if for any unforseen reason you fail to repay the debt. It is important to note that this does not cover you at all (just the lender) so it’s important to consider life / income protection insurance in case you fall on hard times.
Most lenders will also allow the lenders mortgage insurance to be added onto the loan up to 97% of the property purchase price. Therefore our clients require a 5% deposit for the property plus enough funds to cover other costs such as stamp duty, legal fees, registration of mortgage etc. It’s very hard to know exactly how much these “other costs” will be but I recommend allowing 6% of the purchase price, which should cover the costs and give you a guide as to how much you need.
Therefore you will need about 11% of the purchase price of a property (deposit 5%+ other costs 6% =11%) to be able to proceed with an investment property purchase. On a $400,000 property that equates to $44,000. This should be more than enough to cover everything.
If you have equity in another property you may be able to borrow the full cost of buying the property including the costs. This is called “tapping into your equity”. It is vitally important if you do this not to tie your home into your investment property loan. You are ONLY tapping into the equity for your deposit and funds to complete – NOT for the full purchase.
To do this you need to make sure you do a completely separate loan for this purpose not combining it with any other existing loans you have and also not tying it together with the investment property itself. Some people prefer to use a completely different financial institution for the “equity tap” loan and the investment loan so that one lender doesn’t have both lots of business just to keep things completely separate.