Australians have long had a love affair with property, but too often get caught up in the excitement of adding to their property portfolio, overlook the fundamentals, and end up making costly mistakes.
Here are 4 ways to avoid making expensive mistakes:
1. Secure funding first
Banks are continuing to tighten their lending guidelines; driven by pressure from regulators and the Hayne Royal Commission. This has resulted in increased rates on investment properties, higher interest-only rates, and in some circumstances, significantly reduced borrowing capacity. When reviewing income and expense statements, lenders are no longer taking the customers word for it, but are instead verifying statements against bank records. For those who previously understated their actual living expenses, securing additional funding is increasingly difficult.
The key takeout? Before making an offer on a property, ensure you have pre-approval in place, as sourcing funds is not as easy as it once was.
2. Factor in rate rises
The RBA hasn’t moved the official cash rate since July 2016. However, we are seeing home loan rates (mostly those on interest only) on the rise. Why? A major cause is interest rates rising globally, which in turn drives up the cost of funds for Australian Banks, who borrow their lending funds from the global market. While this trend has been occurring for some time, we are now starting to see banks passing on the cost to customers; in some cases increasing interest rates by 0.17%.
This might not sound like a big change, but what happens if the rates rise further – as much as 3%? When you’re considering taking out a mortgage, it’s worth factoring in a stress test – can you afford the repayments if rates were to rise?
"Buying an investment property should be looked at through a completely different lens to buying something for you and your family to live in"
3. Take the emotion out of it
Buying an investment property should be looked at through a completely different lens to buying something for you and your family to live in. Too often, I see people purchase properties in areas they are familiar with, rather than areas with the greatest potential for growth or highest yield. Investment properties need to be scrutinised like any other investment, looking at both the risks and expected return.
Need some help in making the right choice? Consider engaging a professional buyer’s agent. Not only do they have an active finger on the pulse when it comes to economic property trends, but they can often get access to properties that are yet to be publicly listed.
4. Get the right structure in place
It’s important to get the structure right for your loan from the start. Here are some things to consider:
Tax implications – It may be more appropriate to purchase the property in your partner’s name if they’re the lower income earner as this will reduce the tax payable on the income earnt.
Loan structure – Look carefully at the implications of taking out interest-only loans without a buffer or borrowing up to your maximum capacity. Either of these options may put unnecessary pressure on you, should your personal circumstances change, interest rates go up or your loan reverts to principle-and-interest at the lender’s request.
You might also consider alternative ways of structuring the loan; for example, a company could own your asset. Your house could be the collateral for the loan, or alternatively, there may be other, more liquid assets like shares that could be used as collateral. You might be able to lower your interest rate, saving you money.
The lender – Many borrowers who choose to fund their entire property portfolio through one financial institution, could find that their properties are often cross-securitised. This is where the lender takes security across all of all of an investor’s assets, and should the borrower default, the lender has the right to sell whichever property it chooses. Want to avoid this risky situation? One way is to fund each property with different lenders.
If you’re looking to add a new property to your portfolio, make sure you are not taking unnecessary risks. Look at all the options available to you in a calm and rational way. And, if you believe you need a second opinion, don’t hesitate to contact your financial advisor – a simple conversation could save you headaches in the short-term, and potentially thousands of dollars in the future.