Property as an alternative to shares or superannuation


1 . Analysis

Firstly, we need to find out what the limits are for this couple.

A . Borrowing capacity.
John and Jan combined can borrow about $750,000 to buy an investment property. This takes into account an assumed future rent for the investment property.

B . Equity/Savings.
They have $20,000 in savings and some shares and it would be prudent to keep the shares for a rainy day. However, they also have substantial equity in their home which can be used to fund the deposit on an investment property. They have $280,000 worth of equity easily accessible – this would bring their loan to value ratio on their home to 80%.

2 . Recommendations

1 . Release equity from their home.
I would suggest setting up a line of credit of around $150,000 secured by their home. This line of credit is fully transactional, so they can pay their investment property expenses from it and also credit the rent they collect into it. As a result, all transactions are investment property related and the interest on this line of credit is fully tax deductible.

Setting up a line of credit would also mean that when acquiring the new investment property there will be no cross collaterisation of loans with the existing home. This avoids potential issues in the future with banks.
Note: Lines of credit have to be chosen carefully as they come in various states of functionality and price. A good broker can source the right one for this purpose. There are also alternative techniques using offset accounts.

2 . Strategy to purchase an investment property.
Although John and Jan have plenty of equity, their borrowing capacity is limited to $750,000. Since they are using equity to purchase a property and pay on-costs (stamp duty etc..), it essentially means that they can buy 2 smaller properties (around $300,000 each) or 1 larger one (up to about $600,000).

Borrowing would be at 80% of the purchase price, with the rest being financed by the line of credit.

As they will be borrowing over 100% of the cost of the property, it is likely that the property will be slightly negatively geared at a 5% interest rate, and therefore it is very important to ensure that ongoing cash outflow is manageable. In this case the holding costs will be around $30 per week. However, in a higher interest rate environment cash flow would be worse and they need to be comfortable with the result.

They will need a trusted mentor, or advisor, to help them make the best decisions regarding their investment property using the safest strategy and choosing the right property with a good balance of capital growth and rental yield.

3 . Other considerations.
We would be looking at setting up an offset account against their home loan and transferring their savings into it, so they would earn interest on their savings at the same rate they pay their mortgage. The current mortgage rate is 5.1%, current savings rate is at 3.5%. So they would increase their saving interest rate by 1.6%.

Once the investment property is set up, it is recommended they then concentrate on repaying their home loan first (or adding to their offset account), as it is not tax deductible, before they think about repaying their investment debt.

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