Trying to start out

[Kookie7]

Before I get to my question I just want to say what a fantastic forum this is, such a wealth of information! and thank you for taking the time to read my thread.

Regarding my post, I am trying to plan my plunge into the property investment market. To help set the scene, I am turning 22 this year, work full time within a real estate agency, have $30,000 of savings in the bank, no other properties and no debt.

I plan on using the $30k in savings to start my portfolio but am a little overwhelmed with the direction I should go. I was planing on using about $15 - $20k as a deposit and having the other $10k to cover the associated sale costs and be a buffer for emergencies. I live on the Mid North Coast of NSW and am looking at units in my area which range around $140,000 - $150,000 and return from $190 - $210 per week.

From what I've read the best course of action would be to pay as little deposit as possible and obtain an Interest Only (IO) loan with an offset account (putting my savings into the offset account to reduce interest and possibly go towards the principal later?). This is what I'm not certain on, if you only pay the interest on a property, once the IO period runs out you are required to pay the P&I correct? So what do you do in this situation, do you sell before this occurs and reinvest elsewhere or do you bite the bullet and pay it off to own the property? Is there any advantage towards working towards owning an investment property at all or is it always best to owe money on it.

My confusion probably arises from always being told to pay off your debts to own what you bought but I'm guessing investing in property is a little different. Whats the best course of action for a starter?

Thank you kindly.

 

[Jamie M]

Hi Kookie

Welcome to the forum.

Generally speaking, when the IO term expires, you can roll it into another IO term.

The IO with an offset structure that you've described for your first IP sounds good. Sounds like you've been doing your research.

Cheers

Jamie

 

[matto_]

The purpose of the io loan is to maximise tax deductibility. Hence while the property has some tax benefits remaining, you might as well maximise them. It also shows max cash flow for other investments.

 

[Paul Thewlis]

Hi Kookie,
You'll find that the capital growth in your property is where you'll make your money rather than paying down the loan. The interest is tax deductible if it's used for investment purposes. Using an offset account is good for saving interest but make sure you get some tax advice about how to manage your offset account so you maximise you tax position.

Most property investors refinance their IO loan to another one before they go P&I or ask their lender to extend the IO period.

I'd suggest you do a funding budget for your purchase that includes the purchase price, stamp duty, mortgage insurance, other statutory charges, loan establishment costs and legal costs. Then subtract what you want to spend of your own money from this to work out what loan amount you need. Remember that the higher the LVR and loan amount the greater the mortgage insurance will be (assuming you go over 80% LVR).

Regards
Paul

 

[pennyk]

There are a number of young investors on the forum at the moment, looking at buying their first property, as an investment.

I think many people on the forum were like me, buying an IP after PPOR, so we used our equity in our PPOR to cover the deposit and minimise the money we needed to put in up front.... even though it is cross collatorising, it did provide opportunities to get ahead financially, with minimal cash outleys.

Are there any similar opportunities for people starting out with IP's.. I guess the FHOG..anything else?

 

[Aaron_C]

Kookie it looks like you've got everything worked out. Now you need to find the right property.

 

[Kookie7]

Thank you all for your responses. It is comforting to know that I'm least some-what on the right track.

I do have a few more questions if I may:

1. Jamie_M says that a lender will likely roll over an IO term into another IO term upon expiry, however, is there a limit (generally speaking) to the amount of times a lender will keep allowing you to renew the IO term? Do they ever feel inclined to refuse you to renew the IO term thus forcing you into P&I payments?

2. The advantage of an IO loan is an increased cash flow allowing the purchase of additional properties, if for example, I decided to purchase two properties with IO loans and offset accounts, is it better to divide savings equally into the two offset accounts or is it better to place savings into only one of the offset accounts?

3. Finally, is the goal to ever outright own the investment properties in your portfolio at some stage or is it better to always owe money on them? (for the tax benefits). If it is to own I'm guessing the most effective way to own the properties in your portfolio would be to use the capital gains from certain properties you sell to pay off the loans? I guess if you always owe money on the property eventually the rent and value of the property will exceed any payments required?

Hope these questions aren't to disjointed and thank you for reading.

 

[Aaron_C]

1. You can usually extend it for another 5 years after the initial term. After that they will generally ask you to pay down P&I but at that stage (hopefully) you can then refinance to another lender who will give you another interest-only term with a bigger loan amount to withdraw some equity.

2. You really only need one offset account. In the situation you highlighted it makes no difference whether 100% of money is in one offset or if 50% in each.

3. Yes that is right. Some people like having debt but lots of professional investors eventually sell some of their portfolio and repay all their debts, keeping everything else unencumbered. It depends on the individual.

 

[Paul Thewlis]

Hi Kookie,
I have a client who is in his mid 60s and has over 20 properties. He has had about the same number of properties over the 10 years I've working with him but the properties haven't been the same ones - buy a new one sell and old one type of thing.

He still has significant debt on the properties but they pay for themselves now. In the earlier years he leveraged hard with 90-95% loans to buy more properties. As his portfolio has matured and he has got older he has allowed the increase in property value to reduce his LVR so that the properties can be self funding.

Whether you pay of all your loans or just reduce the LVR is up to you when you get to that stage. You are in building stage at the moment - worry about the paying off later. If you pay off your loans too early you might miss some opportunity to leverage into another property.

Regards
Paul

 

[Rolf Latham]

Whether you pay of all your loans or just reduce the LVR is up to you when you get to that stage. You are in building stage at the moment - worry about the paying off later. If you pay off your loans too early you might miss some opportunity to leverage into another property.

Regards
Paul

Sound advice............ accumulation vs exit strategy.

important to have a view on both, however with the window being decades long, an immediate exit strategy isnt required, BUT a risk management strategy is

ta
rolf

 

[Paul Thewlis]

Hi Rolf,
Thanks for the supporting comment and I agree on the risk strategy. Property investing usually relies on negative gearing against your salary or other income. Lose your income and you lose your negative gearing benefits (not to mention your ability to cover the loan repayments). Income protection is an important part of the investment strategy which I find many of our clients haven't considered until we raise it with them.

Regards
Paul

 

[MIW]

Hi Kookie,
I have a client who is in his mid 60s and has over 20 properties. He has had about the same number of properties over the 10 years I've working with him but the properties haven't been the same ones - buy a new one sell and old one type of thing.

He still has significant debt on the properties but they pay for themselves now. In the earlier years he leveraged hard with 90-95% loans to buy more properties. As his portfolio has matured and he has got older he has allowed the increase in property value to reduce his LVR so that the properties can be self funding.

Whether you pay of all your loans or just reduce the LVR is up to you when you get to that stage. You are in building stage at the moment - worry about the paying off later. If you pay off your loans too early you might miss some opportunity to leverage into another property.

Regards
Paul

Yes your advise I agree with.
Well bought property over time becomes neutral and then even positively geared as this has happended to me too. This refers to cash flow so its a secondary consideration.
When I was younger I didn't understand that and I too thought I had to pay them off sooner or later. However, the strategy should be to build sufficiently large asset base using IPs, so first consideration (not many people can pay off IPs and have a $5M or $10M portfolios but can build IPs portfolio to those amounts with borrowing).
Assume you buy $400K IP with CG around 7%. So if in 10 years it will double you will make $400K.
So what will it cost you? Assume 3% so $12K a total of $120K over 10 years to make that $400K.
This is a very simplified example and for NG to work then CG must outstrip holding cost (expenses) and you should have other buffers (financial) in place.
I have used this explanation that M Yardney (great mentor to learn from)used and it makes total sense to me.