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Nicki, 49, is divorced with three children.
I’ve got three kids and I’m single, so if I don’t look after me then no one is going to look after me. My parents were able to help me and my husband with a deposit when we first got married, and so were his parents, but I don’t feel that I’m in a position to help my kids. That’s quite scary, and with Sydney prices so high now it worries me I won’t be able to give them the deposit that we were given. I want to do something for my retirement and my children.
Current income: just under $100K
Line of credit: $150,000 (secured by her home)
Prior to our first meeting Nicki filled in a questionnaire that allowed me to work out key numbers and prepare a focused discussion about Nicki’s options in terms of property investment.
From the questionnaire, I worked out the “boundaries” of what she can or cannot do. These limits are her borrowing capacity, which was about $500,000 and her capacity to fund a deposit. She has plenty of equity in her home, so we could use that as a deposit for a property.
We quickly discussed property and SMSF, but the balance of her current superfund is too low to make it viable to convert it into a SMSF and acquire a property. We then had a conversation in terms of strategy, about how investing in property works, how much savings/equity you need to invest, what kind of cash flow you can expect and how much capital growth can accumulate by the time you get to retirement.
In our initial focused discussion, we covered how to pay her existing home loan a bit quicker and borrow a deposit for the investment property to take advantage of the tax deductibility, rather than using savings. It may appear scary to borrow all of the cost of the investment property but in fact, if you have a home loan, it is a lot more efficient than using your savings because of the tax deductibility of investment loans. Savings can be kept to offset against the home loan, thus effectively reducing the cost of the home loan which is not tax deductible.
We applied for a pre-approval of $400,000 to get her ready for her first investment property. As she had an unused Line of Credit available we had ready access to a deposit. We just topped it up to $200,000 to increase her buffer. The good thing about lines of credit is that you only pay interest on what you use, not the whole limit. As Nicki is extremely disciplined this is an adequate strategy for her. We would apply different strategies for investors who are less rigorous in their financial management.
We also took the opportunity to negotiate a better interest rate on her property with her current lender, saving her $1,600 a year in interest.
Once her finances were in place, she was ready to purchase her first investment property, hoping for a capital growth purchase providing a safe long-term investment:
Location: Augustine Heights, Queensland
Loan: 104 per cent
Cash flow: $30 per week cash flow positive per week
Expected rent: $390 per week
Growth expectation projection: $300,000 equity growth in ten years
For this property, Nicki used $44,000 for the deposit, stamp duty, etc.. , and $9,000 from her Line Of Credit for the interest during construction. This $53,000 left her more than enough buffer in her Line of Credit for unexpected expenses, or even a deposit for new property.
Any savings Nicki accumulates in her offset account will help her pay her home faster. It’s worth paying that off first rather than touching your investment debt. For every $1 dollar of interest paid on your home, it costs you $1. For every dollar paid on your investment property, it only cost you around 61 cents because of tax deductibility. So you don’t want to pay this investment loan down until the home mortgage is paid off.
Nicki asked me what happens if she loses her job or ends up in a bad way. Great question!
Risk management is very important. The risk management in her case was to have that $200,000 line of credit. She is going to use around $60,000 of that. There’s still $140,000 in reserve.
So even if she loses her job for three months the line of credit can help with this. She needs to be careful as it’s debt and she needs to repay it at some stage, but if she loses her job it’s not the end of the world as we have this contingency in place. If she is never going to get a job again, then she’s have to sell, but she can sell it in an orderly fashion and get the most for it, as the buffer allows her to plan.
Similarly, her personal savings is a good risk minimisation strategy she can undertake herself. She just needs to park her savings in an offset account against her home loan. So in Nicki’s case she will have 2 buffers: one for her investments via the Line of Credit and one for her personal finances via her offset account.
Finally, insurance (income protection, life insurance) is also a powerful tool to reduce risk. Too many people look at insurance as a cost when it should be looked at as an asset in your investment strategy. In Nicki’s case, she is well covered as she works for an insurance company herself and has secured her insurance!