Direction needed please - pay off all debt first or save for deposit?

[Jbird]

Hi everyone!

I have been lurking on this forum for over a year - it has helped me to consolidate my investment strategy (capital growth to replace income in 15 years) and my initial short term goal is to purchase two quality properties in an above average growth area, in the next three years- but I am not sure how to get started.... I have so many questions!

Background:
I am 29, earning $80k husband is 28 earning $75k, and we have one child.
We save $1300 per fn, (have only been able to do this recently, but can now do this longterm), we currently only have $10,000 in savings. We are not elegible to first home owners thanks to a previous property purchased with an ex partner in Vic, and sold 5 years ago.

House situation:
We rent our house cheaply through my husbands work, we pay less than half price market rent so we are more than happy to keep renting here and begin investing in property, aiming for strong capital growth and having others pay off most of the mortgages for us.

Debts:
We owe $16,000 on a car loan, (repayments slightly above minimum at $350pfn) and we both have hecs/help debts - husband owes $5000 and I owe around $12k.

My questions are:
Should we pay off the car loan first, and/or our hecs debts, or continue saving for a deposit on our first IP, then focus on debt elimination?

We want to get into the property market ASAP - what are the pros and cons of a 5% deposit?

What are the pros and cons of capitalising LMI?

What are the pros and cons of house and land packages vs established properties?

What are the pros and cons of more, less expensive properties or fewer, more expensive properties when growing a portfolio?

How do I work out how many properties / or the total value of properties we could purchase, negatively geared, before we won't be allowed any more loans?


Thanks everyone, any light that you can shed will be most appreciate!

 

[Shahin_Afarin]

Low percentage play is to do both and ask for a delayed settlement. Most people on the forum are going to suggest established but I see value in building new in areas like the c/c if you can get your hands on a well priced vacant block near the station.

 

[ZOMG]

My questions are:
Should we pay off the car loan first, and/or our hecs debts, or continue saving for a deposit on our first IP, then focus on debt elimination?

We want to get into the property market ASAP - what are the pros and cons of a 5% deposit?

1. Sell car, get cheaper car and become loan free. I would not bother paying the HECS debt as it is only adjusted for CPI...i.e. if I owed 20k in HECS and had 20k in cash I could pay off the HECS and get 0 return from it OR put it in a deposit for an IP that would generate more than the CPI increase. Not sure if this reasoning is correct.

2. Afaik if it's your first home, if you pay less than 20% of the value of your home (LVR >80%?) you need to pay mortgage insurance. The amount of insurance depends on size of loan, e.g. for my loan, the mortgage insurance would've cost ~$10,000 which is a significant amount, so I deposited 20%.

 

[monalisa]

2. Afaik if it's your first home, if you pay less than 20% of the value of your home (LVR >80%?) you need to pay mortgage insurance.

You need LMI for any purchase (regardless of first home, or IP) where deposit is less than 20%.

 

[BayView]

There is a terrific debt reduction plan in the John Burley book; "Money secrets of the rich; the 7 money steps".

Basically, you put as much excess funds into the smallest and highest interest rate loans first and pay them off ASAP.

You continue to pay off the other debts which - although larger - are lower interest rate loans at the minimum repayment amount.

Then, you put the excess funds being used to pay out the smaller loans into paying off the next smallest and/or higher interest rate loans, and so on.

If you are really disciplined, try and do the above, as well as start putting some funds away towards a deposit. As soon as you have a deposit, you can start.

 

[Graemsay]

Compare the interest rate of your loans to the sort of returns you could expect to get from an investment.

A car loan could be anything up to 16% or 17%. Unless your surname is Buffett, you're highly unlikely to earn more than that from any investments, so it's prudent to pay it down.

In contrast, a HELP loan is indexed at 2% this year. I don't know about HECS, but am guessing it's a similar rate. What rate are you getting after tax on your savings? If it's higher then don't sweat it, if it's lower then pay it down.

 

[Propertunity]

Should we pay off the car loan first,

Look it is always better to get rid of consumer loans that are not tax deductible. However, as the property market is moving higher in NSW espcially, you risk missing out on a lot of good CG over the next 2 years say, while you busy yourself paying down what looks to be a fairly minor car loan.

....and/or our hecs debts,

Pay these off as your income allows. I think there is no interest (??) anyway on these loans.

....or continue saving for a deposit on our first IP,

This

....then focus on debt elimination?

What debts are we talking about? A $16K car loan? Look, when you have paid the car loan off, you will likely need another car. Car loans are a fact of life. (OK it helps to have a company and a company car - so the loans are tax advantaged.)

We want to get into the property market ASAP - what are the pros and cons of a 5% deposit?

PROs:
Get into the market quicker
CONs:
Have to pay MI

What are the pros and cons of capitalising LMI?

PROs:
Preserves cash
CONs:
Pay interest on the loan for MI

What are the pros and cons of house and land packages vs established properties?

PROs of established:
You know what you are getting - you can inspect it
Established trees, parks, infrastructure, facilities
CONs of extablished:
Some maintenance issues
May not be your idea of the "perfect" property. There is always some compromise.
PROs of new:
Lots of depreciation
Low maintenance
CONs of new:
You have to pay interest (with no rent coming in) as the loan is drawn down to pay the builder's progress payments
Builders can & do go bust mid-project
Unknown costs (typically site costs - until you get out of the ground)
Dealing with claims for faulty workmanship
Usually out in new estates without good services in the initial years

What are the pros and cons of more, less expensive properties or fewer, more expensive properties when growing a portfolio?

I don't think you need to decide that now. You can have that discussion when you have a few properties under your belt.

How do I work out how many properties / or the total value of properties we could purchase, negatively geared, before we won't be allowed any more loans?

Oooooh the bank will let you know.
Most people only hold 2-3 negatively geared properties at a time (so it does not impact too much on their lifestyle). After the neg. geared ones go neutral or positive, you can buy more.

 

[Darlogus]

Jbird, you are about to start a very exiting phase of your life.
There are many different strategies and you will gets lots of different, something conflicting information due to investors risk profile and goals.

only my opinion below.
To replace your income in 15 years means high income producing properties or $3 million in property without any loans at 5% interest earned will give you 150k pa.
To do this there are several ways of going about it, but each of them require putting together a significant portfolio.
I would say see wat your risk profile is, which will give you a better understanding in the type of property and strategy you will commit to and then go for it.

I started also with a 15 year plan to buy 10 properties in 2001 and the issue I hit was the bank would not give me any more money after 4 properties.
Was on a similar income and my properties were neutral geared.

One of the things I hear a lot and is also right for myself is I should of bought more when they were cheaper.
Once you learn how banks lend you will see how many IP you can purchase before you come to a holt.

There are some members on here with over 5 million portfolio. Maybe they can give you some tips also.

 

[Peter_Tersteeg]

Should we pay off the car loan first, and/or our hecs debts, or continue saving for a deposit on our first IP, then focus on debt elimination?

This depends on how tight your affordability is. If your income and other financial say you can only afford to purchase $400k of property but you want to buy more, then paying off other debts will increase your affordability (substantially). On the other hand paying off other debts will eat into your deposits which will likely delay your ability to purchase because you need to put some of your own money into property purchases.

We want to get into the property market ASAP - what are the pros and cons of a 5% deposit?

Pros: You need less money to get started.
Cons: Most lenders charge higher interest rates, LMI is extremely expensive (compared to having a 10% deposit), accessing equity becomes harder because there's less margin in your equity from the start.

Keep in mind that not only do you need a 5% deposit, but you also need funds for other purchase costs such as stamp duty, rates adjustments, conveyancing and possibly the LMI (see next question).

What are the pros and cons of capitalising LMI?

Capitalizing the LMI means it's added to the loan instead of you having to pay it out of your pocket. This means that you don't have to come up with as much cash up front. Keep in mind that not all lenders allow you to capitalise the LMI.

What are the pros and cons of house and land packages vs established properties?

Pros: You get a shiny new house built to spec, stamp duty is less because it's based on the land value (not the full end value), the first home owners grant tends to be more generous in most states.
Cons: They tend not to be in as good locations, they tend to be clones of each other, you pay a premium price for new. All this adds up to them not being a very good investment.

What are the pros and cons of more, less expensive properties or fewer, more expensive properties when growing a portfolio?

Pros: Easier to purchase more properties, generally has a better rental yield.
Cons: Likely to have lower quality tenants, capital growth may be less predictable and possibly lower.

Note: Really hard to make any accurate statements on this one, it very much depends on where and what you buy. I've seen plenty of examples contradicting these pros and cons.

How do I work out how many properties / or the total value of properties we could purchase, negatively geared, before we won't be allowed any more loans?

Easy if you know exactly what the values of the properties will be, the capital growth and rental yields. Then predict what the interest rates will be in the future as well as lender policy, your income, government tax policy and a really, really smart mortgage broker will able to tell you how many properties you'll be able to purchase and when.

Realistically there is no way to determine this with any true accuracy, especially on your own. A mortgage broker may be able to give you a vague indication, but there's too many variables and unknowns.

BTW: If you do know the answers to the variables above, give me a call. There's far easier ways to make far more money money than property investment if you know for certain what interest rates will do and why they'll do it.



Overall, the best thing you can do is to sit down with an investment savvy mortgage broker who can look at your overall situation and help you start ot develop a longer term strategy.

 

[china]

Pros: Easier to purchase more properties, generally has a better rental yield.
Cons: Likely to have lower quality tenants, capital growth may be less predictable and possibly lower.


.

Really informative post PT, thank you.

With regards to quality of residental IP tenants, I am not sure that you can say that someone who pays $320 per week rent is of lower quality than someone who pays $500 per week.

Presumably, the property manager has vetted the tenants and ability to pay. Hence the $320 tenant as far as reliabilty goes can be just as good as the $500 payer.

As a tenant many years ago, I have been in both situations due to professional circumstances which required me to be in different locations. I can't say my quality changed just because I was paying less or more.

With regards to the treatment of the property - there is no evidence that the 500 dollar tenant does not give it more wear and tear than the $300 tenant.

 

[Peter_Tersteeg]

Agreed China, like I said, it's a very tough question to answer with absolute accuracy.

I also don't define the low end of the market as a tenant paying $320 a week. In my mind this is probably just under the median. Low end would be $220 a week or less. I'm fairly certain I could look at my client list over the last 12 months, check out their rental statements apply a statistical analysis and verify this.

Fortunately I've had very few 'bad tenants'. My IPs are all in good suburbs at median price points. I've not going for either the top or low end of the market. Personally though I've usually had better tenants when they're on above average incomes.

Of course a good counter argument is that there tends to be a minimum amount people can pay thanks to government assistance. In these scenarios rental assistance can often be paid directly to the landlord so you're often guaranteed a minimum amount.

My parents come to mind as well. They've got a property that's right at the bottom end of the market. Whilst they've had some good tenants, they've had quite a few truly terrible ones as well, including drug dealers.

Overall I'd say the 'average' property in the 'average' area (neither high or low end of the market) has a better tenancy track record than the extreme ends of the market.

In my own experience and talking to other investors over 15 years some observations are:
* Good and bad tenants are everywhere.
* Some low income people are very happy to have a roof over their heads and will go to extremes to make sure they keep it there.
* A good tenant can become a bad one very quickly if they're in a separation or loose their job.
* Some people will feed their kids before paying the rent.
* There's a few good, lots of average and a few bad property managers.
* People who self manage can do a brilliant job and enjoy excellent results.
* People who self manage tend to be targeted by serial bad tenants.
* People who self manage tend to have a higher percentage of bad tenants.

 

[Deltaberry]

Good/bad tenants is a hit/miss thing. But from observation, the chances of coming across a tenant who doesn't pay rent/smashes your fence is more likely to occur at suburbs with lower median prices.

 

[BayView]

Really informative post PT, thank you.

With regards to quality of residental IP tenants, I am not sure that you can say that someone who pays $320 per week rent is of lower quality than someone who pays $500 per week.

True.

We have had a varying socio-economic range of areas and IP levels.

Most - lower end, but one was higher end - 3x2 DLUG townhouse in complex of 4, brand new - in Mentone, right near beach, train and Mentone Grammar. It was beautiful...wooden floors, deck and so on.

Expected rent at the time was $450p/w, ended up with $350p/w

The tenant we got was a middle-aged nurse with 2 teen kids who went to Mentone Grammar..

She was a nightmare to all the other residents there. Kicked her out in the end.

Conversely, we have an IP in Kalgoorlie - 2x1 which has mostly been never vacant, and never had a bad tenant....terrific rent return as well.

There is no magic formula, and often lower end folk are good people with no money, but are honorable.

Get good LL insurance.

 

[Aaron_C]

Every tenant is different. However, I would take my chances on the tenant who pays $600 per week versus the one who pays $200. Why? Because the guy who pays $600 is more likely to be on a better income, whereas the person on $200 would be at the lower end of that plus most likely to be on Centrelink. I don't think you can truly argue that people on the lower end are less likely to be problem tenants? People are people but demographics do not lie.