Serviceability is stopping me

[SupaRex]

Hi All,

I have a few properties, but still consider myself very inexperienced when it comes to investing, so please forgive me if this is a dumb question.

This isn't exactly my position, but it will illustrate my question best.

Lets say I have $300k in equity in my property portfolio.

Now, I want to buy a house worth $300k. Even though I have the equity, I still have to physically borrow the $300k because I can't give equity to the seller (right?).

My actual question is: given this situation, the repayments (even allowing for rent) would kill me. Is there some (advisable) way I can use the equity I have to help pay the repayments? Is there some other obvious strategy I'm overlooking?

Any advice/help would be much appreciated.

SR

P.S - I know the bank will only (typically) loan 80% of the $300k and there are borrowing costs, but I left all that out to try and keep things simple and more clearly illustrate my point (although I don't know if I've succeeded yet!).

 

[Rolf Latham]

Hiya Rex

Yes there is a way

its called Capitalising Interest

Is it a smart thing.............right now maybe not, though I cant advise on that. Only you could draw a conclusion that its worth to borrow against the possible future gain.

ta
Rolf

 

[BoatBoy]

Maybe the banks are telling you something?

Dave

 

[Rixter]

SR, as Rolf suggests you can capitalise the shortfall in your IP holding expenses via a LOC and/or offset account.

Lets say you have a LOC used purely for investment purposes with a credit of say $150k.... you can draw down on that to fund your IP deposit ($60k) plus purchase costs and borrow the remainder ($240k) of the purchase price ($300k) via a another loan secured against the new IP.

All your income/s including rents get put into the LOC and each month your IP loan/s is debited from the LOC to pay the interest on the IP loan/s.

Any shortfall between income/s into the LOC and debit/s out of the LOC increase the LOC balance. Most lenders dont require you to make any interest payment on the LOC until your LOC balance reaches your LOC credit limit.

The idea behind capitalising the interest is that your portfolio is growing faster than what you are capitalising and as such your net wealth is increasing with out you having to inject any of your own money.

You are effectively buying time to allow your portfolio to increase in value so you can increase your credit limit to buy you further time. The length of time you'e buying is determined by the available funds in your LOC, how fast your portfolio is appreciating in value and how much you are capitalising.

Whether this strategy is for , well only you can weigh up the pro's & con's of your individual situation and make the decision. Everyone is different, with different situations, strategies, goals, time frames, and personal risk profiles. No method fits all.

Hope this helps.

 

[stumunro]

As Rixter has explained the jist of it, I will explain the biggest downfall..which is if you are capitalising a certain figure (say 15k for example) per year, you need to allow yourself enough years remaining in the LOC for your property to grow further in value. If we see a stagnant market for the next half a decade will you have enough money in there to cover the costs... and even if you do..will it have been worth using all your equity??

When you are looking at advance strategies it's important you don't over commit and timing is more important then ever...

Seriously think about it and no decision like this should be made rashly.

 

[Rixter]

The biggest downfall I see most people experience is they find out they have hit the DSR wall after they have already exhausted it and cant set up a LOC to even start this strategy.

Its a classic catch 22 situation!

You need to have the foresight to plan ahead and have things already in place before the DSR rears its ugly head.

Hope this helps.

 

[Rixter]

SR this is another option I have used to get around banks serviceability issues in the past. It maybe of interest to you.

I have used a Cashbond/Annuity to keep purchasing IPs. I used it in conjuction with my CGA Strategy -

When you have a few IPs under your belt Serviceability will eventually become an issue. The banks/lenders will not lend you money due to you not meeting their standard lending criteria. As you know banks/lenders work out serviceability under 2 modules - LVR & DSR.

Where the majority of investors start to reach their borrowing capacities is in relation to the DSR or Debt Service Ratio. In other words not enough cashflow income to service your IP debt. Now this isnt really a problem if you can increase your income. But how can you do that

Obviously there are many ways as the mind can conjure up. But the main ways most investors know of is to increase you PAYG income and/or increase your IP rental income. As these methods are fairly well reliant and restricted to market conditions alot of investors dont know where to go to from there. Alot forget about the store of Equity they have with their low LVR's created over time by past capital growth.

Thats where a Cashbond or Annuity comes into play - which is method I have implimented to get me around the lack of serviceability issues and allowed me to keep borrowing to build my Portfolio.

A cashbond basically works by converting existing equity into cashflow for the purposes for increasing your income in the eyes of the banks/lenders.

The way it works is as follows - you purchase a Cashbond/Annuity or guarranteed income plan from an insurance company. That Insurance company then pays that back to you plus interest over a nominated term - usually 5 years. You purchase the Cashbond using funds with drawn from a LOC.

For example if you purchased a $100,000.00 cashbond over a term of 5 years, each year you would get $20,000 plus interest paid back to you. Now when you go to the bank for a loan to purchase your next property you can show 100% of that $20,000 income on the INCOMES side of your loan application on top of your existing Payg Income & all your other rental incomes...In other words You have effectively increased your borrowing because you have an extra $20,000 income in the eyes of the banks. Pretty neat hay

You can also use that cashbond income to service your portfolio holding costs as well.....this giving you sleep at night factor knowing you can service the debt comfortably.

This how I have been able to keep purchasing. Now I know this method is not for everyone. It all depends on your circumstances, goals, time frames & your individual investor risk profile.

Hope this has provided you & everyone else with some food for thought.

 

[SupaRex]

Hi again,

Firstly, thanks to everyone for their valued input - much appreciated.

Just with the capitalising interest, is the interest still tax deductible? What about the other costs (if any) that go with a LOC?

Cheers,
SR

 

[SupaRex]

Hi Rixter,

Just on the Cashbond/Annuity strategy, what are the risks involved (generally speaking)?

Thanks again,
SR

 

[Rixter]

Hi again,

Firstly, thanks to everyone for their valued input - much appreciated.

Just with the capitalising interest, is the interest still tax deductible? What about the other costs (if any) that go with a LOC?

Cheers,
SR

As long as you dont contaminate any personal expenses in with your property holding expenses then there is no issue.

 

[Rixter]

Just on the Cashbond/Annuity strategy, what are the risks involved (generally speaking)?

SR,

CON's -When you use a CB you are effectively purchasing (at a cost to you) an Income you can then use to increase your servicability in the banks eyes. Also you have locked your equity away for the CB Term purchased, however you also have the option to cash it in and get your equity out again after its served it purpose of increasing your DSR and the bank has already given you the IP loan.

The cost to puchase this income is brought about by the difference between your borrowing to puchase rate and your return rate being paid back to you from the insurance company for them to use your borrowed funds. This rate difference can range between 2-3% depending upon who you decide to puchase through.

PRO's - The advantages of using a CB over Lo/No doc is it allows you to keep building your property portfolio and hold more propertys and increase your aset base over what you would normally be able to purchase without a CB. For example a CB will allow you to increase your aset holdings to approx four times the CB purchase price over and above your current capacity. ie $150k CB will allow you $600k approx extra aset base.

The extra CG achieved by increasing your portfolio aset base (providing you have done your homework & bought well) more than offsets your CB purchasing cost over the five year term.

Other added bonus- Because you require the CB funds to allow you to keep building your income producing property portfolio the ATO allows the rate difference/shortfall to be claimed as a tax deduction, plus you can use some of the funds being returned to you cover your property portfolio holding expenses, thus increasing your SANF.

In summing up - You are effectively purchasing an income so therefore it comes at a price. You should examine your own personal sitution and decide whether its for you only after you have explored and/or exausted all other less inpacting options available.

Hope this helps you.

 

[SupaRex]

Hi Rixter,

Please excuse my extreme ignorance, but my knowledge of LOC's is very limited.

The LOC is against the equity in my portfolio right? But is it treated as a cash advance in that I would have to pay interest on any money I used? If that is the case, do I just capitalise that too?

Many thanks and I appreciate your patience,

SR

 

[stumunro]

Hi Rixter,

Please excuse my extreme ignorance, but my knowledge of LOC's is very limited.

The LOC is against the equity in my portfolio right? But is it treated as a cash advance in that I would have to pay interest on any money I used? If that is the case, do I just capitalise that too?

Many thanks and I appreciate your patience,

SR

a line of credit will be a separate loan against a portion of the value of your property. Alot of the times, yes, the interest is paid with the LOC itself. This happens automatically, they just draw down on the loan, like a credit card.

 

[Rixter]

The LOC is against the equity in my portfolio right? But is it treated as a cash advance in that I would have to pay interest on any money I used? If that is the case, do I just capitalise that too?

Yes the bank adds the interest charged from the previous month to the LOC balance.

Does this clear it up for you?

 

[SupaRex]

Yes the bank adds the interest charged from the previous month to the LOC balance.

Does this clear it up for you?

Yes, thank you. Obviously you would have to be careful, as it would seem to me that the compounding interest of the LOC would quickly add up.

 

[SupaRex]

Wouldn't having a LOC reduce my capacity to borrow? Or is that a known thing and you only use this strategy when you have heaps of equity but no cashflow?

Cheers.

 

[Gools]

My actual question is: given this situation, the repayments (even allowing for rent) would kill me.

Have to ask, with interest rates as low as they are, are you setting yourself up for a fall? There are a fair number of neutrally geared properties being sold at present. Why would you want to get up to your neck in negative gearing at this stage of the cycle?

Gools

 

[Rixter]

Wouldn't having a LOC reduce my capacity to borrow? Or is that a known thing and you only use this strategy when you have heaps of equity but no cashflow?

When working out your DSR the bank will look at your LOC as if its fully drawn up to your credit limit even if it has a $zero balance.

 

[SupaRex]

Have to ask, with interest rates as low as they are, are you setting yourself up for a fall? There are a fair number of neutrally geared properties being sold at present. Why would you want to get up to your neck in negative gearing at this stage of the cycle?

Gools

I would be happy to nab a neutrally geared property, I guess I was being conservative and assuming I'd only be able to get a negatively geared one.

 

[silversands]

LOL Rex!

Then stop assuming and get to researching. You can chose from an abundance of neutral homes right now! Positive is becoming more readily avail too!