Getting 1st IP Preparations

[chran]

Hi all, long time lurker, first-time poster so please be gentle

My partner & I just got our first property which is going to be our PPoR (settlement Jan-Feb 2008). I'd like to be able to buy 1st IP as soon as possible. At the moment the numbers look like:

PPoR: 425k - 15k deposit = owing 410k + interest
1st income: 4800 per month (after tax)
2nd income: 2800 per month (after tax)
Savings left (after stamp duty, removalist etc): 10k

My plan is to keep the mortgage under control by dumping as much as we could on repayments (to offset account). The budget looks like:

mortgage: 2900 per month (plan to switch to fortnightly)
living costs: 2000 (exaggerating a bit, spent max 1800 per month in the last 12 months)

The leftover, 2700 per month. 1k goes to repayment, plan to spend the rest to furnish the place slowly, as needed (washing machine 1st month, vacuum 2nd month so on - hoping to stop buying big stuff in 12 months so all 2.7k could go towards mortgage).

Given the above situations, my questions are:
1) Should we plan to get 1st IP that's cheaper than PPoR or the other way around?
2) How long will it take to build enough assets for our first IP?
3) How should we structure the IP-buying side of things (ie. set up Trust/ Company etc?) This is the part that confuses me the most - willing to learn though.

Awaiting your suggestions, comments or criticisms

 

[JoyBoy]

I'm in a similar if not identical situation and plan on buying my first IP after I settle on my PPOR. The reason for waiting until after I settle on the PPOR is that I want to guage how much my living expenses will actually be as opposed to what my budgeted living expenses are for when I move into the PPOR. This will ultimately determine my serviceability of any future IPs and accordingly determine the price the of first IP.

I was quite surprised that your living expenses are only 2000 per month. Is this normal or have I over budgeted my living expenses? The partner and I spend about $300 on train fares a month (2 x $150), $200 on petrol a month (4 weeks x $50), at least $400 in lunch a month ($50 each x 4 weeks). That's already $900 and we haven't even looked at groceries, bills etc.

In relation to your questions 1) I've decided to buy a relatively cheap IP just to learn from the whole experience. If i make a loss, I don't want it to be a big loss and to learn from my mistakes.

3) You have to keep in mind the costs with setting up and maintaining a trust/company such as lodging tax returns etc. I'm personally going to purchase IP's in my own name and offset the losses against my personal income. Obviously if you're in a higher tax bracket, the greater the savings. The good thing about a trust is that you can distribute income to beneficiaries as you please.

 

[chran]

Hi JoyBoy,

we don't have a car and not planning to get one until 2009 (save money). We've been using public transport for the last 5 years.

Yes, we live on 2k per month. Like I said, spending never goes beyond 1.8k in the last 12 months. No it is not normal - we choose to live like this so we can save more. It was hard at first but now very used to it (so it's sustainable).

Good thinking on cheaper IP just to "take a dip" - will definitely consider it. As for Trust structure, I need to learn more since it's an unknown territory for me.

If you dont mind me asking, how much do you budget for living costs?

 

[Bandita]

Hi Chran,

Welcome!! You'll find a wealth of knowledge here!

Just a quick thought on your strategy - IF you're planning on purchasing an IP using the deposit from your offset account of your PPOR, it might be smarter to actual stick that money (the amount you want to use for the deposit/purchase costs) into your loan so that you can redraw it from your loan and then as you're using those funds for an investment the interest will be tax deductible - rather than increasing your loan on the non-tax deductible PPOR if you pulled it out of the offset account.

That's only of course if you're planning on using those funds for your deposit/purchase costs. If you're getting the funds from elsewhere (like from the equity in your PPOR), then it's irrelevant.

I would plan on purchasing an IP cheaper than your PPOR. For many reasons, some being that the yield will be better, the deposit/entry costs less, wider tenant market, and also it's having a cheaper entry into the investment market meaning there will be less trouble if things go wrong while you're figuring it all out!

In terms of your living costs - they sound about right if you're good budgeters - but have you always been renting or have you owned before? Aside from the mortgage, your living costs may go up by owning the home due to the maintenance/rates/other issues you don't have to deal with while renting. If you don't have furniture yet - you may not have lived on your own before(?) and then you'll find that your living costs will go WAY up!

In terms of how to structure your investments - best to talk to an accountant, and there are some great ones on this forum. It's different for everyone what works and really depends on your long term strategies/goals.

Cheers,
Jen

Cheers,
Jen

 

[JoyBoy]

Hi JoyBoy,

If you dont mind me asking, how much do you budget for living costs?

Well in addition to the above expenses, I've also apportioned other expenses over a monthly basis including car insurance $700, rates $1300ish, and then you have water bills, electricity, gas, house and contents insurance and of course the internet, all of which I can't put a figure on because I haven't had to ever pay these yet and thus my reason for waiting until i settle into my PPOR before committing to an IP. Some see the internet as an entertainment expense whereas I see it as a necessity .

I can't remember the exact budgeted figure but it was approximately $3000 a month. I have a feeling that it might be excessively high, but I like to be conservative in my estimates to ensure that I have all my bases covered.

 

[chran]

Hi Jen,

Totally agree that SS rocks. Been reading for the last 2 months & learning lots .

stick that money (the amount you want to use for the deposit/purchase costs) into your loan so that you can redraw it from your loan and then as you're using those funds for an investment the interest will be tax deductible - rather than increasing your loan on the non-tax deductible PPOR if you pulled it out of the offset account

Could you please give more details? To me it looks like both methods use money from offset account of our PPOR hence no difference (I'm sure I'm missing something ).

funds from elsewhere (like from the equity in your PPOR)

Given our conditions, which one is the faster way to accumulate enough to get our 1st IP?

IP cheaper than your PPOR

This is good advice - thanks!

We've been renting so far - we have some furniture and plan to keep them until they need to be replaced. That's why I budget min 1k extra repayments instead of 2.7k - if we need to buy something the budget for that is 1.7k per month.

On top of that month to month budget we have 10k savings for misc stuff (rates, body corp, etc - the rest goes to offset/ extra repayments). Nothing is written on stone so no dramas if some costs are higher.

Our short-term strategy (3-5 years, sooner the better) is to get 1st IP. Long-term is to get more IP's and mix with shares (diversity). Ultimate goal is financial indepence - not relying on super, work because I want to NOT have to, doing what I like etc.

talk to an accountant, and there are some great ones on this forum

Definitely looking for one. Where're they hiding ?

Again, appreciate your excellent feedback.

Cheers, Chran

 

[Bandita]

Hi Chran,

OK - the offset account - I LOVE them - but they can mess up your tax deductibility if not used correctly.

Firstly, you have your "loan" - either a deductible loan (used for an IP or other investment loan) or a nondeductible loan (PPOR, car, lifestle, credit card, whatever - basically if it's not used for something that's producing income or a Capital gain that you will have to pay tax on - it's not tax deductible)

Then you have your offset account - this is a seperate account, which is the same as a savings account, except it has that lovely extra bonus that it "offsets" against the loan you have it set against. If the loan you have it set against is your PPOR or other non-tax deductible loan, when you take the money out of the "offset account" the existing loan is still a non-deductible loan and therefore the extra interest you pay when withdrawing funds from the "offset account" is not deductible - no matter what you're using the money for.

If the loan you have it set against is a deducible loan (IP/investment loan), when you take the money out of the "offset account" the existing loan remains tax-deductible loan and therefore the extra interest you pay when withdrawing funds from the "offset account" is deductible - no matter what you're using the money for.

Taking a step back - there are 2 types of loans you can have - Principle and Interest, or Interest Only. If you have an Offset account against your loan - it makes a difference on the type of loan you have. If you have a Principle and Interest loan with an offset account against it - you will pay the same amount each month, but the amount you saved in interest will be put towards the principle component of the loan. However, if your loan is Interest Only, then the Offset account will reduce the interest you pay each month by the amount in your offset account - and therefore reduce your monthly repayment.

Ok, back to a PPOR loan (non-deductible) - with offset account against it - if you pour all your funds into the offset account and plan to use the money in the offset account to use for a deposit on an investment property, your loan against the PPOR will increase (not in reality - same loan, but less offsetting it) and that increased interest you pay will not be tax-deductible because the loan still remains against the PPOR.

If you instead plan on using the deposit/entry costs for an IP/investment by redrawing the equity in your PPOR, then the interest on that portion of the "redraw loan" becomes tax deductible.......

So, if you want to use the money for you deposit from the PPOR equity - it can either be from "growth in the property" or "money (equity) you've put into the property"

But if your savings plan is to use the funds in the offset account to purchase a property - if you have a good idea of what you will need for a deposit/entry costs for a property and put those into the property (with a redraw facility), then you can "redraw" those funds for your deposit - and the interest on that portion of the loan will be tax deductible.

Not sure if that made sense - it's easier to show on a pen and paper Keep asking questions if it isn't - it will eventually - there's a good thread on this somewhere, I'll see if I can find it.......

Cheers,
Jen

 

[chran]

i settle into my PPOR before committing to an IP. Some see the internet as an entertainment expense whereas I see it as a necessity

I agree, the truth will be revealed first couple of months after settlement. Internet IS necessity nowadays - I can't live without it for too long.

 

[chran]

money out of the "offset account" the existing loan remains tax-deductible loan and therefore the extra interest you pay when withdrawing funds from the "offset account" is deductible

Thank's for explaining that. So if I use this strategy, we end up with 2 offset accounts (1 PPOR & 1 IP). Obviously from investing perspective the second method (tax deductible interest) is preferred.

I guess in 3-5 years time I'd have to get our PPOR valued and see how much equity we have. Compare this with what we'd have in offset and use the more powerful asset to get the 1st IP. Somewhere in between we'd need to get a great accountant .

You mentioned the 2 loans (IO & PI). Is it true that most people use IO loan for IP's and PI for PPOR?

Currently our main strength is in extra repayments (can pay extra 40-70% pm). How to best use this fund to get 1st IP (assuming 1st IP is going to be cheaper than PPOR, so up to 350k mark)?

 

[chran]

2.5 years later...

Fellow forumites,

It's almost 2.5 years since I bought my first PPOR. I'm now reviewing my ability to get the next one. Here's the current situation:

1. Pre-approved for 500k (Dec 2009) - with LMI
2. IO loan on PPOR - 1700pm (will become IP after the next purchase)
3. $$ in Offset - 46k
4. $$ in shares - 8k
5. Household income - 176k (pre tax)

The plan is simple: get a bigger PPOR and turn the current one into IP. However, I'm having doubts because of these:

1. I'd like to have 600k limit (have buffer in case I buy with my heart - it's the next PPOR so brain may lose )
2. Bank says we don't have enough $$/ equity to avoid LMI

As you can see, our serviceability is good. Is there a way to use this to get the PPOR upgrade without LMI?

Should I consider a refinance in case there's another lender that isn't as conservative in evaluating my property?

Do you think I move to fast (The beginnings of this thread, the original plan was to buy cheaper than PPOR, once every 3-5 years)?

 

[chran]

bumping this since I haven't got any replies

 

[Rolf Latham]

LMI may just be a cost of the dream....then u may get a better val from another lender, a hard one

ta
rolf

 

[chran]

may get a better val from another lender, a hard one

ty Rolf - what do you mean by a hard one? hard (tough) lender or hard to get better val or hard decision?

 

[Rolf Latham]

decisions

spending money without a known outcome is always hard

ta

rolf