Latest idea - thoughts please

[MikeR]

So here is the latest idea. Would appreciate some thoughts as this is all new to us, having never owned anything more than PPOR.


Background
Wife, 2 kids (9 & 7). Combined income $220k.
Current PPOR is a beautiful, large home in Sydney's north.
We owe $1mill on it, IO for another 4 years then P&I for 25 years. 100% offset.
No other loans.

Last bank val was 12 months ago when we refinanced with a Big 4. Thought it was a little light at $1.3m, but we didn't push the point because it was enough to keep our $1mill under 80% LVR.

No IP's.


Idea
As much as we love the home, we now feel like we would be content with something a little less grand in return for a lower mortgage, less stress, paid off sooner etc etc.


Of course, perennial problem is that whilst we see now as a good time to buy, we know it is not a great time to be selling.

Agents are saying our place would get about $1450k - $1500k, although in current market that could just as easily turn out to be $1350k which to me would be giving the place away.

We have found a place nearby that is not too big a downgrade and say we bought for $950k and sold for $1380k, we could bring our mortgage down to $650k which is the sort of thing we are looking to do.


However, even selling at $1380k would seem like we are throwing money away by not waiting for the market to improve.


Ideal solution would be to buy now and rent our current place for 5 or 6 years and hopefully by then the market has picked up a bit and we can sell our current place for a much better price and reduce the remaining mortgage even more.

Current place would rent for $1,500 per week.


Ideally, I would like to get current PPOR valued at $1425k to allow us to borrow another $140k at 80% LVR on that property.

Using that $140k and buying at $950k, we would need to borrow $850k at 89.23% LVR on the new property (no cross collateralisation, open to whether it would be with same bank or different bank to 1st property).

I appreciate this would would require LMI - from what I gather, around $15k on these numbers (someone confirm?)

Total borrowings would go from $1mill to $1.99mill (so much for reducing the mortgage)


We realise that in the short term until we sell our current PPOR, this little strategy wont help our financial stress (probably increase it), so the plan may be doomed to fail before we start but we are just trying to see if there is a way to get ahead over the next 10 years other than just hoping to win Lotto (which will be difficult as we hardly ever buy lotto tickets).


Not knowing a lot about IP's, I'm figuring the rent less rental expenses will cover the interest only cost on the existing $1mill (or close enough to covering it), leaving us to repay the other $990k of borrowings from our salaries, which is what we are doing now anyway.

Are we mad to be even thinking about something like this ?

I know getting a bank val of $1425k for our current property will probably be a stretch and there are no guarantees the market for our place will yield any better price in 5 or 6 years time to justify the stress of carrying $2mill in debt for that time.

We probably should be looking to buy at $800k, not $950k, but that is likely to require too much of a downgrade and therefore not the trade off we would be willing to make.

On a more practical note, maybe we are dreaming to think anyone would lend us $1.99m on our current income + (expected) rent.


Would appreciate your feedback. Reality checks will be accepted with the good grace in which they are given.

Maybe we should just buy and sell now and be happy with reducing the mortgage by $350k.

Forgive my newbness.

 

[Aaron_C]

Hi Mike,

You might be able to pull it off but only if you are comfortable with saving and being dedicated to maximising your cashflow. If sudden expenses come up etc it will cause you serious problems.

 

[wylie]

Current place would rent for $1,500 per week.

Where did you get this figure from? Have you confirmed it by searching the net for similar properties for rent?

We realise that in the short term until we sell our current PPOR, this little strategy wont help our financial stress (probably increase it)...

If you are financially stressed already, I'd guess increasing your debt with a hope that things will improve is not a good idea. I'm all for holding property, but you need to look at what holding will cost you for five to ten years.

Not knowing a lot about IP's, I'm figuring the rent less rental expenses will cover the interest only cost on the existing $1mill (or close enough to covering it), leaving us to repay the other $990k of borrowings from our salaries, which is what we are doing now anyway.

What about the ongoing weekly cost of rates, insurance, maintenance etc? I always look at rent in, loan out, but there is so much more to it. Again, if you are financially stressed, you need to look at the total expenses, not just the interest.

We probably should be looking to buy at $800k, not $950k, but that is likely to require too much of a downgrade and therefore not the trade off we would be willing to make.

What if you put your own house on the market, see what the feedback is. You might miss out on the $950K house, but if you sell for a price you are thrilled with, you can sit and cherry pick something for a good price.

Would appreciate your feedback. Reality checks will be accepted with the good grace in which they are given.

Maybe we should just buy and sell now and be happy with reducing the mortgage by $350k.

Forgive my newbness.

There are few things worse than being stressed financially. If it is an issue, I would be wary of borrowing more, in the hope that the costs of holding for another five or so years are negated by at least the losses being recouped by a larger sale price.

I don't know what I would do either. But I know at times through our 25 year marriage, the times when we didn't have money and had to borrow to get through the week were tough.

Any time, we could have sold an IP to fix things, but we always wanted to hold on in the hope the market "fixed" our problems. It did, but sometimes it took a long time, and sometimes I think selling earlier and reducing our debts would have been just as good a strategy.

 

[Empty Pockets]

What is your land size and current interest rate?

If it is your dream home I would be staying put. You may regret a downsize in a few years.

 

[Rolf Latham]

Hi

If you buy and sell in the same market, then the pain will be a little less, though upsize usually works better in a flat market than does downsize.

Once you are a little more comfy with the new mortgage payments, you could then look at doing some investing in property with the equity created

ta
rolf

 

[MikeR]

Thanks for the thoughts so far.


@Wylie
Rent figure was given by local agents. Lesser property across the road rented for $1300 in less than a week. If not $1500, then at least $1400 should be achieved.


We are not "stressed" as such. Wife is only working 3 days and could kick that up to 5 days if need be (but would prefer not to). We have just formed the view that we would be happier with a lesser house, but a bit more cash to spend on other things now, longer/better holidays etc etc and still possibly be looking at being mortgage free sooner.

Nevertheless, agree that taking on more debt at this point is somewhat the opposite of the overall goal and definitely a gamble (and I am normally pretty risk averse).

That part of the idea is really being driven by the feeling that we would be ripping ourselves off selling our current house in this market and therefore we are looking for away to have our cake (buy now in low market) and eat it too (sell current property later in higher market). It may be too much to expect we could pull that off.

When I said "rent less rental expenses", I meant rent after rates, land tax, property management etc (although I was guessing some of these, eg PM @ $100 per week ??). I worked on $78k of gross rent (@ $1500/wk) giving me about $65k net rent after those expenses to then cover the interest on $1mill. Rising interest rates would of course, leave us negatively geared.


@empty pockets
Current Land size is 696sqm. Place we are looking at is actually 750sqm, but the house is a little smaller and of a lesser standard and doesn't back onto a National Park like our current place. Nevertheless, it is a downgrade we are confident we will be happy to live with.

Current interest rate is under 6.5% but was just quoted 6.29% to lock in part of the loan for 3 years fixed.



Any thoughts on whether we would be better off (or more chance of getting approval) using the same bank/financier or by trying to split the two properties between two different banks ?


The current $950k place we have seen is not the be all and end all (the price isn't down at $950k yet either) so if we miss out, we miss out. There will be others. Like I said, maybe we need to find something in the $800's, not $900's, for this to work.

 

[davidw89]

Hi MikeR,

Thank you for sharing your story with us. Firstly, it takes courage to admit that you have a problem and to do something about it. Most people stay in denial until the problem snowballs, by then it's probably too late.

I can be quite honest and to the point but bare with me.

Does anyone else think that the problem is not with the debt itself but the cost associated with maintaining a lavish lifestyle. Robert Kiyosaki once said that as your income goes up, your expense also increases in proportion. It's worth going back to the core and asking ourselves, is having to maintain a large home worth it? Is it making me any happier or just more stressed out?

An interesting quote, and i'm not attacking you directly, but i hope that you'll get angry enough to do something about it, realising full well that the bank is making a killing from your loan:
"Spending money we don't have, on things we don't need, to create impressions that won't last, on people we don't care about." Interesting how our society has been wired toward materialistic consumption.

One question, on a combined income of 220k per year, conservatively, how much do you have left after the taxman takes a cut, the bank takes a bigger slice and of course, deducting your expenses and so forth. If you have any other debt, add the repayment as expenses too. Be honest with yourself, this will give you much better indication of your cash flow, which is the first thing that we need to calculate when faced mortgage stress.

I'd like to point out that i would not be comfortable taking more debt in your particular case, though i could be wrong.

In regards to the mortgage, you might want to consider paying principal and interest instead of interest only. Use a mortgage calculator, you'll find that P&I saves a significant amount over the course of the loan. There's two way to pay off your mortgage faster, lower the interest rate (ask your bank for a lower rate or refinance) or make extra repayment. There's no easy way out. Taking on more debt doesn't solve this problem.

There's a really awesome website that tackles personal finance in an interesting light. Scott Pape from the http://www.barefootinvestor.com/ has some really good tips when it comes to managing your money. Have a look, i'm sure you'll get something out of it.

In particular:
http://www.barefootinvestor.com/pages/signup-3/

I would look into seeing a professional, a qualified financial planner who would be able to help you with your personal goals. What is it? To reduce debt? To buy another property? To downsize? To free up cash flow? The execution is just as important and i'm sure there's a lot of tax implication involved that can get quite tricky.

EDIT: Interesting article on whether to fix your interest rate or not:
http://www.heraldsun.com.au/businessold/to-fix-or-not-to-fix/story-e6frfh4f-1225764996458

Here's my recommendation:

1) If you choose not to downsize, look into ways to pay off the mortgage faster. This would not only save you hundred of thousands of dollars off the total cost of your mortgage but it would help build some much needed equity. Did you know that by taking an interest only loan for $1,000,000 over 30 years equate to you paying the bank ~$1,000,000 principle AND ~$2,000,000 worth of interest over the course of the loan. That's after tax money by the way.

2) Look into ways to save on your daily expense, pool that fund into your offset account. Make regular repayments! First, start with a planner and see where your money are headed.

3) Do you have savings in place in the event of unforeseen circumstances, such as either you or your spouse losing your main source of income. Life isn't perfect, things do go wrong from time to time and having some rainy fund in place will make a big difference. The barefoot investor calls this your MOJO money, stashed away in a high online savers account so that you know it's there should anything happen.

4) If you do end up downsizing, i would look into a property that would require me to take on as little debt as possible. Yes that would mean that you won't be able to show off your fancy property, but i would be happy without the added stress. Look into LVR of >50%, that way i have a larger margin of safety and excess cash flow for your holidays! It would also allow me to pay off my mortgage faster and get the banks off my back. That feeling you get when you own your home outright, that is my goal for the next couple of years =-). Then you could use the equity in that to borrow for your dream home, with the benefit of something to fall back on and rentable income.

5) Follow the 20-10 rule when purchasing a property, that is a 20% deposit factoring in a 10% hypothetical interest rate. Can you afford to maintain your current property if interest rate was at 10%?

On a brighter note, you have a staggering amount of income coming in, which gives you a lot of choice. If you pay your cards right, you can be debt free, savings in the bank and maybe even financially free, which is another way of saying never having to work again for the rest of your life. At the end of the day, it's your call. Everyone of us has to make a choice when it comes to our finances. What will yours be?

Keep us updated MikeR.

Regards,
David

 

[MikeR]

Thank you for sharing your story with us. Firstly, it takes courage to admit that you have a problem and to do something about it. Most people stay in denial until the problem snowballs, by then it's probably too late.

Thanks for your reply David and the links.

I am not sure I would have described myself as having a problem and having had the courage to admit it, but then again, that might be the "denial" you speak of, ha ha.

Anyway, I can certainly identify with the quotes you raised. That is exactly where we are at - making a choice about having a lesser house that still leaves us very comfortable, but at a lower cost.


The goal is definitely to have a lower (or no) mortgage a lot sooner and we have the scope to downgrade and still be very happy and comfortable.

I say downgrade, not really downsize, because I am talking about giving up all the premium quality aspects and fixtures of our current house that make it a beautiful house, but can easily be lived without in return for lower debt.

We are pretty much sold on this idea already subject to finding the right new place.

The taking on more debt idea is really just a short term strategy that says, instead of selling now for $1380k (a giveaway) and buying for $950k for an end result $650k mortgage, maybe we could buy now for $950k, sell in 6 years time for $1700k for a net result of a $300k mortgage (less whatever other principal has also been repaid over 6 years).

My basic assumption is that the capital growth on my current place over 6 years will exceed what I could otherwise pay off the $650k mortgage over the same period, with the rental income covering the holding costs.

What I probably need to go away and do now is some analysis on just how much of the smaller loan could we pay off in the "sell now" strategy over the next 6 years as perhaps the compounding effect of extra repayments against the $650k loan will be more than first imagined.

At least in that approach, I will have more control over how low I can get the mortgage down to compared to relying on some unknown, uncontrollable future capital growth windfall to reduce the debt.

 

[Aaron_C]

"In regards to the mortgage, you might want to consider paying principal and interest instead of interest only. Use a mortgage calculator, you'll find that P&I saves a significant amount over the course of the loan. There's two way to pay off your mortgage faster, lower the interest rate (ask your bank for a lower rate or refinance) or make extra repayment. There's no easy way out. Taking on more debt doesn't solve this problem. "

Sorry I don't agree with this. If Mike wants to convert his current PPOR into an IP the best thing he can do is put money into his offset, not repay the mortgage...as this will cause him much more problems in the future.

Anyway Mike, your overall strategy is a sound one. It is always best, purely financially speaking, to have more invested in your IPs than your PPOR. It just makes more sense cashflow and equity-wise. If you make this sacrifice now, hopefully in 10 years' time when you look back you will be in a far stronger financial position than if you just paid off your PPOR mortgage and just had that as your only asset.

 

[Adelaide]

Have you considered these couple ideas;
1. If you rent your current PPOR, the portion of original interest to purchase the current PPOR becomes tax deductible when your tenant moves in. You can set up your wage to get the tax back each month thereby helping your repayments.

2. If you decide to rent your current home and live in a rented property, you have up to 6 years to sell your current IP before you have to pay full capital gain tax applied to investment properties. If you buy your next PPOR, then this 6 year rule does not apply. Check if this still applies.

3. When considering the value of your home for a refinance, consider it as a fire sale value and not the actual market value. You may well be disappointed in the valuation you get back.

Perhaps you should chat to your accountant to see what financial benefits you have.

If you go for another loan for the new property and you are keeping the current PPOR, I prefer to use different lenders and stand alone loans. Safer.

You could always sell the IP and purchase the new property and change securites but keep the old loan. This can be trickier to achieve, but saves you in new loan fees and time.

Good luck.

 

[Aaron_C]

You could always sell the IP and purchase the new property and change securites but keep the old loan. This can be trickier to achieve, but saves you in new loan fees and time.

No matter what banks tell you, there's no such thing as 'keeping an old loan' if the security is sold/changed. It's just a new loan with the same customer at the same/better rate.

 

[Adelaide]

Aaron C...I'm talking about portability on the loan. I've done it several times.
Sell a property and port in the new security on that loan cause the whole loan is better on the old loan. Usually costs around $300 and a valuation each time I do it and I don't have to show financials all over again because the loan is usually staying the same or getting smaller. Doesn't work if the loan has grow bigger.

Everything has to be apples for apples - names on both loans exactly the same, same or smaller loan and everything to happen on the same day.

Everything about the old loan remains the same except it's secured by a different property.

 

[Terryw]

Have you considered these couple ideas;
1. If you rent your current PPOR, the portion of original interest to purchase the current PPOR becomes tax deductible when your tenant moves in. You can set up your wage to get the tax back each month thereby helping your repayments.

2. If you decide to rent your current home and live in a rented property, you have up to 6 years to sell your current IP before you have to pay full capital gain tax applied to investment properties. If you buy your next PPOR, then this 6 year rule does not apply. Check if this still applies.

3. When considering the value of your home for a refinance, consider it as a fire sale value and not the actual market value. You may well be disappointed in the valuation you get back.

Perhaps you should chat to your accountant to see what financial benefits you have.

If you go for another loan for the new property and you are keeping the current PPOR, I prefer to use different lenders and stand alone loans. Safer.

You could always sell the IP and purchase the new property and change securites but keep the old loan. This can be trickier to achieve, but saves you in new loan fees and time.

Good luck.

I was going to suggest this too. On those salaries you could be saving a fair bit of tax which can go into the offset account and help the cashflow.

You may even be able to buy another property to rent out as well.

You get to keep your dream home, save tax, and get another IP as well as avoid the CGT on the main residence.