AND… CAN THEY SAVE ME MONEY?

At property loan advisor we deal with a lot of enquiry when speaking and advising clients on what type of mortgage is suitable for them. The options appear to be endless and can be confusing. The key is to have a loan product that will help save you money, offer flexibility and help you achieve your goals.

THE OFFSET ACCOUNT

The simplest way to describe an offset account is a normal everyday transaction or savings account that is linked to your home loan. That means when the mortgage lender calculates the interest to your loan, they take the balance in your offset account off what you owe on your mortgage and apply interest on the reduced amount. So at the end of the month when interest is added, a lower amount of interest is added to the loan. These savings could be quite significant just for letting your accumulated funds and wages sit in your account.

The bank or lender may charge transaction fees, but most lenders will waive transaction charges on offset accounts altogether, they are more likely to charge a “package fee” for the loan, offset account and a credit card. Many clients like to have all of their salary paid directly into the offset account. This ensures that any income not spent is being used to reduce the balance of your loan. While receiving the interest savings you also have the flexibility to access your funds at any time.

The below example is based on one of our clients – they have $50,000 in their account and it offsets $50,000 on their loan account, having the effect of interest only being charged on $300,000 instead of $350,000. As you can see the savings are quite substantial and the clients have the ability to access the funds at any time they need to.

Albert Einstein said that compound interest is the eighth wonder of the world I am going to suggest that Mortgage Offset Accounts are the ninth wonder of the world! These accounts have so much flexibility and can save you lots of money!

THE LINE OF CREDIT

The simplest way to describe a line of credit is that it is like a giant credit card limit, secured by your home. This product has loads of flexibility, although … along with flexibility comes responsibility. Many of our property investor clients love the line of credit product as it is part of their overall strategy for growing a property portfolio.

For example, our client may own a home that is worth $500,000 and currently have a home loan of $300,000. Their goal is to buy an investment property. We can approach a lender to set up an additional $100,000 as a completely separate loan to the existing home loan of $300,000. The advantage of doing it this way is that you have loans set up with different purposes. The existing home loan can remain on a principal and interest loan and the second loan of $100,000 can be a line of credit loan and can be interest only. The line of credit can then be access for the deposit and cost for the purchase of an investment property. The other major advantage of having the loans split into this structure is that you keep your non deductable loans separate from your deductable loans. Check with your accountant if you are entitled to claim the interest on your line of credit.

Many people approach their existing lender with the goal of purchasing an investment property and they are offered an increase on their existing home loan and then they can access the cash through a redraw facility which I will discuss next. The problem with this loan structure is that your borrowings are not separate and when it comes time to tax time you may have destroyed a very nice tax deduction.

REDRAW FACILITIES

A home loan with a redraw facility allows you to borrow money you’ve already repaid and is usually offered with variable interest rate loans. It allows you to use any extra income or savings to reduce the balance of your loan, thereby reducing your interest repayments and “redraw” that extra money in the future should you need it.

Some lenders will limit you to as few as two redraws per year. Others will charge you up to $50 per withdrawal, and some even insist that you redraw a minimum of $2000. Check with your bank or mortgage broker for a redraw facility that provides you with maximum flexibility at minimum cost.

All three options will you to save money, getting the right advice on each facility will not only give you savings on your home loan but will allow you easy access to cash to help you with your goals.

Hi Felicity, I learnt a new word yesterday: macro-prudential. I understand the RBA is also talking about it in relation to investors. It looks like its going to be harder for investors to get loans. What is more scary I heard mortgage brokers saying the banks will soon increase interest rates for investors but keep owner occupiers loans low in a attempt to cool the property boom. Your thoughts? They have been advising investors to consider converting over to fixed interest rate loans.

Hi, great question – interesting term macro-prudential and what does it mean for investors? Macro-prudential controls are financial regulations aimed at minimising the risk to the financial system as a whole, while traditional micro-prudential regulation limits stress individual institutions.

They are measures that are not associated with the monetary policy (raising interest rates) which are designed to slow lending, particularly to property investors.

Some of these measures could include capping loan-to-value ratios or capping debt-to-income ratios or stress testing borrowers capacity to cope with rising interest rates.

At the end of the day, it is anyone’s guess as to what may happen. Growth in the market is not Australia wide and is mainly in cities such as Sydney and Melbourne. When I compare products in the market for investors small differences appear between owner-occupier and investor loans – for example, most lenders that offer Loans at 95% LVR will capitalise the mortgage insurance for owner occupiers but not for investors.

I think regardless of the financial landscape – the most important thing is to check in with your broker or banker when you are transacting a property deal and get the advice to match your circumstances and goals.

Fixed rates are historically very low now and great for locking in and knowing what your cash flow is, the downside is that if you sell the property in the fixed term you can be up for large break cost, so knowing what you want to do with the property determines what type of loan you would take up.

Buying an investment property is not about guessing if it will make you money or not. Being clear on what type of property niche you are working in and how much you expect the property to make will ensure that the property meets the objective making money. Once you are clear on the specifics of the property it makes communicating with agents a whole lot easier and they can be on the lookout for properties that suit you.

If your sole objective is to reduce your tax and that is the only objective you have, you will lose money, for sure. Many people are sold on the idea of saving tax when they buy an investment property. In order to save on tax, you have to lose money on your property investment. The strategy is known as negative gearing. The Australian Tax Office allows you write off any of the losses you have on your investment property against your personal income. Sounds good but is it really? As an example, let’s say you are earning gross $100,000 annually and your tax rate is 35 cents in the dollar, your tax bill for the year is $35,000. Your investment property loses $10,000 in the financial year. For the calculation of the tax, the $10,000 loss is deducted from your gross income of $100,000, making it $90,000, the tax is then calculated on $90,000 making the tax bill $31,500 instead of $35,000. You meet the objective of “saving tax” of $3,500 however it cost you $6,500 to save $3,500.

This is the crazy part, the property has cost you money, and that money comes out of your pocket. Some people argue that the capital growth of the property will exceed the losses. Sometimes it does and sometimes it doesn’t, at the end of the day this is a hope and pray strategy. All too often I see people with 4 or 5 negatively geared properties because they were sold on the idea of “saving tax”. You only have to have one small thing go wrong and it puts enormous pressure on you personally and can force you into a sale that may not be convenient.

If your objective is to make money, look at a property from its income earning potential versus the capital outlay. I have seen too many investors get caught up with the price of the property instead of looking at the return on the property. They are so focused on the actual price they forget about the return.

You can very easily do a “back of the envelope calculation” that requires finding out what the weekly rent potential is versus the value of the property.  If you want to achieve a 5% return you would look for a property where the rent is the same as the first three digits in the purchase price. For example, $400,000 house rents for $400 per week it is roughly a 5% return. In fact, it is really 5.2% ($400X 52 ÷ $400,000) = 5.2%. Try it – it works! Given that interest rates are at an all-time low it becomes easier to seek a neutral or positive cash flow on the property.

If that same $400,000 property only earned $300 per week it would only be a 3.9% return. If the interest rate on your loan is 4.5% you are in a losing proposition from day one. The good thing about a very simple calculation it allows you to sift through and sort out the properties that you may consider buying.

Saving tax is a very poor reason to buy an investment property. The numbers don’t lie, and you can always rely on them. Understanding the numbers on a property combined with some solid market research should yield you a return that you are seeking. Armed with this information you can sit down with your accountant or financial planner and get the appropriate advice to move forward building your property portfolio.

Happy investing

Felicity Heffernan