Switching 1st PPOR to be 1st IP

[anrke]

Hi all,

Firstly, my large appreciation goes out to the people who dedicate what I can only assume is tremendous amounts of time to these forums. I've only been researching them the last week, and feel I haven't even seen the tip of the iceberg yet.

Now that's out of the way; a brief scenario I would appreciate some feedback on.

I am currently renting in a central suburb of Geelong (East Geelong) in an old 3br Cal Bungalow weatherboard home (210pw shared with 1 other). Prior to opening my eyes, I have spent the past 4 months inspecting Geelong homes looking for my first home to purchase with an upper limit of 300k (pre-approved) and a preferred limit of 250k. I currently have just under 18k saved as Deposit, with a helpful older brother able to contribute the remainder required for a 10% deposit. I am currently adding ~1500per month (~35-40% take home pay) to that deposit savings account. I have a small amount left on my HECS debt, car paid off, paid-off credit card, no other debts. Since deciding to buy a home, my savings plan has been far better than it ever was.. my last 10 months saving has gotten me the deposit I have now.

The owner of this rental property is interstate, an on a whim I decided to call him up and see if he had an interest in selling the house. He wasn't against the idea, but needed to speak with his financial adviser as he was nearing or at retirement age and the super laws changes etc etc. I'm going to ring him again this week as it's been about 6 weeks since we last spoke.

The house is in dire need of a new kitchen/bathroom, has an asbestos roof, and would most certainly need re-stumping. Some boards would be rotten and require replacing, and the floors are currently carpeted. It's one of the 'worst houses' on the quiet end of a busy street - and being so close to the city center I believe it would have a lot of potential to have value realised here. In saying that, I've been here for 5 years renting and by no means is it uncomfortable (2nd room extension on the back with a canara fireplace)

So, with all that in tow - I am now considering pursuing the purchase of this place. Value is currently unknown, but I wouldn't want to pay more than 250 for it (which would be below MV IMO; but I need a valuation) with some ideas of either:
1. Paying interest only, rent it out immediately and allow the CGs of the good locality do it's thing.
2. Paying interest only, living in for 12 months, then turning it into an IP to renovate kitchen/bathroom as tax deductible expenses and renting it out for more than it can earn currently. Meanwhile, I would rent elsewhere myself and work to build a deposit/equity for a second IP.
3. Keeping it as my PPOR and work on renovating it myself as a part-time project, while paying P+I as aggressively as possible in it's early years to reduce interest.

I guess i'm only scratching the surface - and I should really speak to the owner before posting this - but I'm just itching to get the ideas out of my head. Immediate concerns with option 1 is I could get a tenant who is far less tolerant of broken things than I am.. and maintenance could be quite high. I also need to find a new place to rent.
Option 2 poses the problem of saving for the reno job quickly, and then having the work done while it's an IP without it being 'off the market' for too long untenanted.
Option 3 makes me wonder how I'll ever get the disposable income to actually purchase an investment property..

I'm not looking for the golden answer, I know one doesn't exist. I'm more just interested in seeing casual ideas/opinions from those with more experience. If the owner is actually keen to sell, a solid inspection/valuation will be required before I even begin to do some financial estimates for myself.

Cheers!

 

[yo yo ma]

... while paying P+I as aggressively as possible in it's early years to reduce interest.

Hi & welcome anrke
If you do go option 3, if would forget the P&I loan... Still do IO with a 100% offset account. This achieves the same thing but allows more tax deductable interest, if you make it an IP later on. All options have their merits... good luck
Steve

 

[steveadl]

If I were you, I'd at lest continue to live in it for the first 6 months so you can get the $7k FHOG - and should'nt really be too much more cost involved either assuming you keep the house mate in.

You also rase a good point that a tennant may want things fixed that you have learned to live with. So maybe during that 6 months that your there anyway, get some of the urgent repairs done. Although maybe check this against how you can claim it for tax in the future - I think if it's your PPOR the costs will get added to your purchase price for future capital gains deduction when you sell, as opposed to an expense in this financial year (but check with others who would know this a lot better than me!).

As far as P&I vs IO goes - ensure you have your strategy worked out first (ie. stay or move out) before you get a certain loan or lock in a P&I rate etc. that can't be changed. If you change your mind in 12 months there could be penalty costs to alter the existing loan.

Also, I'm sure you already have, but make sure you check other houses in the area, and even different options in around town to make sure you're not over paying

 

[anrke]

Thanks Yo yo ma,
Just so I understand the Offset account correctly (because I probably don't!) - the concept is it is an account with the funds available oncall. I deposit all my surplus cash (or my salary?) into this account which I can then draw from if required.

When the bank calculates the interest on my loan, the balance of this account is deducted from the loans principle.
ie
Loan: 240,000
Offset: 20,000

Interest on my loan is calculated on 220,000. If I spend that offset accounts funds next interest calculation will be back at 240,000.

I guess depending on what I do with this offset account determines if it's a good thing for me or not ?

The bank wins if I constantly draw from the offset to buy consumer goods/cars etc, as it was excess money I could have paid directly off my principle. I lose due to poor spending habits.
or..

The bank breaks even because it has my funds which could have been paid off the loan anyway; I win because money which could have been locked away as principle payments on the loan achieves the same outcome in reducing interest - but is available on-call for future investment opportunities.

 

[anrke]

So maybe during that 6 months that your there anyway, get some of the urgent repairs done. Although maybe check this against how you can claim it for tax in the future - I think if it's your PPOR the costs will get added to your purchase price for future capital gains deduction when you sell, as opposed to an expense in this financial year (but check with others who would know this a lot better than me!).

Thanks Steveadl ; these are the type of questions I need to investigate further and have answered so I can have a complete idea of what will be involved in this strategy.

As far as P&I vs IO goes - ensure you have your strategy worked out first (ie. stay or move out) before you get a certain loan or lock in a P&I rate etc. that can't be changed. If you change your mind in 12 months there could be penalty costs to alter the existing loan.

Cheers. I am thinking an IO loan with an offset account probably provides me with the most flexibility in continuing to grow a real estate portfolio. Until last week, I was firmly in the school of P&I and paying as much as possible off the loan to pay it out entirely as quickly as possible.

 

[steveadl]

My thought would be to go IO as well. If you are definitely planning on making it an IP within a year or so - this will give you the extra cash flow for the rennovations etc. month to month, and when it does become an IP, you can keep the same loan, and instead of repairs, use the extra cash for the next IP as you mentioned.

 

[the_captain]

If it were me I'd go IO as well. I
n fact from now on, I will be going IO for ALL properties, including the one that is my PPOR, why you might ask? Well the answer is simple, going IO allows you total flexibility. For example, if you want to live in the house as a PPOR, calculate what the principal + interest payments would have been, and pay that as a minimum into the offset, also tip in any surplus cash you have. If you want to convert it to an investment later, simply take all money out of the IO loan and offset that against your next PPOR, thereby minimising your non deducatable debt and maximising your deductable debt. Have you had a tight month, by now you should have a decent amount of money in the offset to draw on for the interest payment, so you dont have to stress. Interest rates skyrocket / you lose your job, if you have a good amount in the offset, you can sail through these periods, sure it wont be pleasant, and you will be treading water, but you minimise the risk of losing your growth assets. So for ultimate flexability and good risk management IO is awesome.

However, it is not for everyone, you need to be disciplined, you need to be able to save, you need to be able to risk the temptation to draw out $10K / $20K and go on a holiday, or buy doo-dads. Invariably older family members / spouses might freak out that you are not "paying off your mortgage", but ultimately you will get to the point where you COULD pay it off.

 

[dcarr]

anrke, an offset is just a normal account that is "linked" to your loan and interest is charged on the balance of the two accounts. You can re-attach the offset to a different loan.

The bank doesn't mind your offset... they get less interest from you, but can then loan that money on the international market!!

I actually started out on IP1 with IO and offset. It's real simple and very motivating to see your progress as you save. When the offset gets big enough, use it to buy another property. Leave the offset on the highest % loan, or on your PPOR when you get it. Rinse and repeat.

The only problem is that each new IP means two simultaneous hits to your cashflow - the extra repayments on your existing IP due to loss of the offset, and the introduction of repayments on the new one.

I know you can do some very cool things with LOC (line of credit) and frequent revaluations but I don't think offsets are such a bad way to get your first couple of properties going if you're saving well.

 

[anrke]

Thanks all, some helpful information there on the Offset account and how it can be used.

With regards to having a first property switch from being a PPOR to an IP, what considerations need to be made with the bank and tax office?
I know I need to live in it for at least 6months to ensure the FHOG is valid.

After this period, if I move out into a rental property myself (or buy a new PPOR) how do I 'declare' my first purchase as an IP? What needs to change?

I don't want to waste anybodies time, so if there's a quick link you can fire at me which answers this alrealdy that would be more than enough

 

[Simon]

If you were my client I would be persuading you to consider IO with Offset.

Nothing else will be as good if you plan to make a current PPOR into an IP down the track AND buy another PPOR.

Going P&I will cost you thousands later on.

 

[Simon]

Thanks all, some helpful information there on the Offset account and how it can be used.

With regards to having a first property switch from being a PPOR to an IP, what considerations need to be made with the bank and tax office?
I know I need to live in it for at least 6months to ensure the FHOG is valid.

After this period, if I move out into a rental property myself (or buy a new PPOR) how do I 'declare' my first purchase as an IP? What needs to change?

I don't want to waste anybodies time, so if there's a quick link you can fire at me which answers this alrealdy that would be more than enough

You don't declare anything. You just need to be able to show evidence of the situation if ever questioned by the ATO.

No worries about wasting time - we only do this because we have all learnt so much and enjoy giving back to our community.

 

[yo yo ma]

Just so I understand the Offset account correctly (because I probably The bank wins if I constantly draw from the offset to buy consumer goods/cars etc, as it was excess money I could have paid directly off my principle. I lose due to poor spending habits.

Yes, it is the same with credit cards... they can be fantastic if you are disciplined enough to use them to your advantage. The principle of good debt/ bad debt can be found in this post
http://www.somersoft.com/forums/showthread.php?t=24892
Steve

 

[steveadl]

If it were me I'd go IO as well. I
n fact from now on, I will be going IO for ALL properties, including the one that is my PPOR, why you might ask? Well the answer is simple, going IO allows you total flexibility. For example, if you want to live in the house as a PPOR, calculate what the principal + interest payments would have been, and pay that as a minimum into the offset, also tip in any surplus cash you have. If you want to convert it to an investment later, simply take all money out of the IO loan and offset that against your next PPOR, thereby minimising your non deducatable debt and maximising your deductable debt. Have you had a tight month, by now you should have a decent amount of money in the offset to draw on for the interest payment, so you dont have to stress. Interest rates skyrocket / you lose your job, if you have a good amount in the offset, you can sail through these periods, sure it wont be pleasant, and you will be treading water, but you minimise the risk of losing your growth assets. So for ultimate flexability and good risk management IO is awesome.

However, it is not for everyone, you need to be disciplined, you need to be able to save, you need to be able to risk the temptation to draw out $10K / $20K and go on a holiday, or buy doo-dads. Invariably older family members / spouses might freak out that you are not "paying off your mortgage", but ultimately you will get to the point where you COULD pay it off.

That's really interesting, didn't think about it like that before. At the moment I have my PPOR on a P+I loan and also paying more than required every month as well. But I do plan on upgrading PPOR in a few years and keep the old one as an IP.

Have to see what my options are though as it is still fixed for another 18 months or so, and there is currently no offset acc. linked to it. Bank might not let me change it.

 

[anrke]

Yes, it is the same with credit cards... they can be fantastic if you are disciplined enough to use them to your advantage. The principle of good debt/ bad debt can be found in this post
http://www.somersoft.com/forums/showthread.php?t=24892
Steve

I found that link earlier this week - a very good read! Fortunately, apart from HECS I'm in a debt free situation; and the HEC's is very small on low interest which doesn't bother me at all.

Now - at the expense of starting a new thread I thought I would continue here with a new question. I keep getting offers in the mailbox for free house valuations. Will Real Estate Agents happily evaluate the property that I currently rent in? Do they ask for some kind of proof of ownership, or if I just book a time and so long as I have the keys to the front door will I be fine? I have spoken to the owner in Sydney and he is happy for me to get it valued. Do I even need to 'pretend' I own it to the Real Estate agent, or just say it's on behalf of the Sydney owner.

Additionally, how accurate can a Real Estates evaluation be without a formal building inspection? Can I assume that anything they don't mention on their evaluation which later comes up in a building inspection can help in bringing down the cost I'll negotiate with the owner?

I'm hoping having a person initiating the purchase of a property which wasn't already for sale (ie pro actively engaging the owner!) isn't totally new here

 

[dcarr]

In my experience before a REA comes in for the "free evaluation" he'll have already pulled up your house and street sale history and other data, so he may even know the name of the current owner.

Had a sticky moment once when I took up a "free evaluation" straight after a private purchase... first thing he said was "you just bought this place yeah?".. he obviously knew i was being cheeky just wanting validation of the purchase price. Fortunately he was a good sport and gave me an estimate of what he would've listed it for.

Best bet is to be honest.. they do have access to a lot of info If you say you're looking to make it an IP and ask about their PM services I don't think there'll be a problem.

 

[anrke]

Thanks dcarr - perhaps saved me some embarassement.

I'm assuming (and sometimes I do that too often) that the sales history/street data etc they can pull up is paid for or private data not available to the general public? ie me!

 

[turk]

I don't think letting the agent know that you may be buying the property as an IP is a good idea as the agent may contact the owner to try and list property.