$14k Debt Paid-off, Now Where to Begin?

[ARF]

First of all, an introduction. My name's Adrian, 21, and I've been lurking around hear for about a year.
It's my first post, as when I graduated in December last year, I came out with a $14k personal debt and haven't been in a position to do anything investing wise. Two weeks ago I paid the last of it off (not a bad effort I think for a $58k salary!)

Anyway, I'm after some advice on where to begin with my investing. Part of my plan is to save $2.5k and margin lend at 50%LVR into index funds (Aus shares, Int shares, LPTs and Gold etc.) in an 80/20 equities/cash split and continue to add regular cash and loan amounts each month.

My aim is to buy my 1st IP whilst maintaining a dollar-cost-averaging approach to the index funds. My criteria for property (broad) are:

• $200 - $250k
• Townhouse with land component (courtyard etc.)
• Minimum 2 BR
• >4% yield (gross)

Based on this, I will need about a $20k deposit (95% LVR). Is it possible to borrow against equity in shares for the deposit? i.e If I have $25k in shares can I use 80% ($20k) as an equity deposit similar to borrowing against existing property? What are the implication of this (if the value of the equities drops, will the bank call my loan etc.)?
Is this a risky strategy, and would my effort be better placed in saving in an account?

Thanks in advance, any comments on my plan/criteria etc are welcome (good, bad and ugly!)

 

[Peter Parker]

First of all, an introduction. My name's Adrian, 21, and I've been lurking around hear for about a year.
It's my first post, as when I graduated in December last year, I came out with a $14k personal debt and haven't been in a position to do anything investing wise. Two weeks ago I paid the last of it off (not a bad effort I think for a $58k salary!)

Adrian, you deserve to take credit for saving over half your salary. The plan you describe looks good. Banks prefer equity in property, so maybe buy a place, add value to it and use the equity for your share purchases.

I'd imagine you still had that debt and keep putting that amount away high interest savings account until you've worked out what you're going to do with it.

Possibly have $1000 per month taken out of your pay to top up the index fund and the rest (over $1000 per month) to put towards a deposit on property No 2 (maybe put into an offset account?).

What about future growth:

Assuming:

saving $30k pa
borrowing 100%
asset yield: 5%
asset holding costs: 13% pa

there's a shortfall of 8% of asset value which your $30k pa must cover.

$30k/0.08 = $375k maximum asset base that can be serviced

HOWEVER it gets better.

Assuming the costs of holding the investment are tax deductible, there could well be another $10k more as you're no longer paying income tax. Indeed your taxable income might be so low that you qualify for the 'low income tax rebate' So you could *just* service a half million dollar portfolio on current incomes. Add to this any equity you get through value adding and appreciation, but the great thing about these two things is it lowers your LVR for future purchases.

This doesn't make allowance for rising interest rates/costs/vacancy (-) or rising job income/rising rents (+) so won't be accurate.

That half million dollar portfolio above is good, but to achieve it safely it should possibly be built up over a couple of years rather than borrowing it all in one go. This is so you can let rising rents increase yield and improve serviceability.

The main thing that will retard your growth is yield, so if you can obtain 5 or 6% that will permit you to buy more quicker than being satisfied with 4% yields. Getting more equity is also good, so if you can add value by buying well & tidying the place up (even if it's only a $20k gain) then that will help towards the deposit on the next property. A pre-1980s house might be better than a townhouse for adding value purposes, though at the cost of building depreciation for a post 87 property (which would probably be a unit or townhouse given your price range).

Peter

 

[whitehope06]

HOWEVER it gets better.

Assuming the costs of holding the investment are tax deductible, there could well be another $10k more as you're no longer paying income tax. Indeed your taxable income might be so low that you qualify for the 'low income tax rebate'
Peter

Hi Peter
Sorry I don't understand this part , how ARF would be qualify for the "low income tax " ?

 

[Peter Parker]

Hi Peter
Sorry I don't understand this part , how ARF would be qualify for the "low income tax " ?

If your taxable income is below a certain amount, you become eligible for the low income tax rebate:

http://law.ato.gov.au/atolaw/view.htm?locid='PAC/19360027/159N'

Properties that cost more to hold* than they provide in rental income reduce a person's taxable income.

In some circumstances this can make them eligible for the rebate, whereas if they had no leveraged investments their taxable income would be too high.

(*) Note that building depreciation is counted as a holding cost, so it is possible for rental income to exceed outgoings but for the property to be making a loss (and thus reducing your taxable income) in the eyes of the ATO

 

[whitehope06]

If your taxable income is below a certain amount, you become eligible for the low income tax rebate:

http://law.ato.gov.au/atolaw/view.htm?locid='PAC/19360027/159N'


(*) Note that building depreciation is counted as a holding cost, so it is possible for rental income to exceed outgoings but for the property to be making a loss (and thus reducing your taxable income) in the eyes of the ATO

ok, let's see if I understand it correctly.
In case of ARF :
his income is about $58K
the taxable income limit is $48,750
so if his cost of holding the IP is about $10k (rent income - expense ), he would be qualify for low income rebate ?

 

[Belu]

whitehope thats pretty much it. it would also drop him below the medicare levy so if he didnt have private health insurance he would save another $580 (1%) plus the $150 (1.5%) difference the medicare normal levy would put on him.

 

[ARF]

Hi gys, thank for the replies.

Spiderman, my savings rate will probably decline slightly now that I'm out of debt. I was sacrificing a hell of a lot, mostly because that cloud over my head was quite depressing.
I feel the need to relax a little now. Having said that, I'm banking on being able to put away $350-$400 a week.

Assuming a $250k place with a 95% LVR I'd be negatively geared to about $200 a week after costs before tax (rent at $230).
I like the idea of building a $500k asset base. I could do this with 2 x $250k properties say over the next two years, using equity in IP1 to fund IP2?

As you say, the debt should be servicable after tax, depreciation etc.

Whatever else is left over after servicing the debt would be funnelled into shares. Although I think with such a high LVR I might shy away from margin lending on top of that.

Now to be patient and get started! Thanks guys.