Leveraging Investment property to purchase first home

Chris wrote:

Do i need to be looking at properties with expected high capital growth or is the positive cash flow property the right strategy and i am missing something.

Hi Chris

Welcome aboard.

It’s each to their own. Personally, I prefer to purchase properties in high growth areas, renovate and hold. These properties are usually neutral or negatively geared slightly.

A property that doesn’t go up in value over time isn’t going to assist in reaching your goal of purchasing another.

The extra few dollar from a cashflow positive property probably isn’t going to make a world of difference either given your relatively high incomes.

Cheers

Jamie

Chris wrote:

Thus, my next question if you have time to answer is; If I can generate equity in the IP through renovation or other means, what methods are available to access that equity down the track to use as a deposit for a PPOR.

Hey Chris

If the IP increases in value – either via growth, improvements or a combination of both, you can access this equity by setting up a second loan split alongside the current IP loan. That second loan will fund the deposit/costs on your IP.

So if we take a simple example for illustrative purposes, let’s say you’ve bought an IP for $100k and took out an $80k loan (so loan to value ratio of 80%)

You then renovate and it goes up in value to $125k.

The bank will let you borrow up to 80% of the properties value – so you decide to take that $80k loan up to $100k (which is 80% of the properties value now – and it’s $20k more in borrowings). You borrow that $20k as a second loan (so you now have two loans against the IP – the first is the original $80k loan and the second is the new $20k equity release).

You then decide to use that $20k to cover the deposit/costs on your new PPOR – which is worth (for illustrative purposes) $80k. You then set up a third loan to cover the remaining balance for the new PPOR.

So all in all, you now have two properties and three loans.

Investment property (worth $120k)
Loan 1: $80k loan
Loan 2: $20k equity release (covers 20% deposit and costs on new PPOR)

New PPOR (worth $80k)
Loan 3: $64k (80% of the $80k purchase price – with remaining 20% deposit and costs coming from loan 2 above).

This is a very simplistic explanation and your PPOR will probably cost more than your IP – but hopefully this provides you with a bit of an idea.

It’s important to structure the loans like this because a) you can easily distinguish deductible debt (loan 1) from non deductible debt (loans 2 and 3) and b) you’re avoiding cross collaterising the two properties (I won’t get into that in great detail now because this post will never end!)

Cheers

Jamie

Hi Chris

Is there a reason why you want to buy an IP first prior to buying your own home.

Depending in which State you are you in and where you purchase the IP you might end up shooting yourself in the foot when it comes to Stamp duty concessions etc

There are a couple of ways of buying an IP without actually putting down any deposit and borrowing 100% of the purchase price without using other equity. We have done this on a number of occasions for many other forum members in the same boat as yourself.

Course has to be the right property but can certainly be done.

Cheers

Yours in Finance

superAndrew wrote:

One thing to point out. It wouldn’t be advisable to use an IO loan for positive cash flow property. A better strategy would be to use the rent to pay down the principle as soon as possible. This will not only increase your equity in your property but will lower your interest expense and hence increase your cash flow.

Andrew

I completely disagree. :)

This leaves little flexibility and causes potential tax issues moving forward. A more appropriate strategy would be to have an Interest Only mortgage with full transactional offset. The same reduction in interest applies, however you can access that increase in funds for both investment and personal usage. By paying P&I, if you were to use the funds for a non investing purchase the loan will be ‘polluted’ and accountant will need to apportion the deductible and non deductible portion, minimising tax deduction and increasing accounting costs.

Very interesting post and a lot of food for thought.
One thing I am curious about is how the equity loan works? Is it any different to a standard home loan? As in does it have the same interest rates, can it be paid over the same long period.etc?

For example my home loan is 350k and my home is valued at 450k meaning i have 80k equity available.
If i wanted to draw this equity for an IP how would that look? Would i be paying:
350k loan on my PPOR at say 5.5% over 30 years costing me $458 a week.
80k loan of equity at the same meaning I now need to pay $458 plus the additional $104 equity loan per week? Meaning my payments have now gone up to $562?

Of course there would also be the IP loan but that I understand. I am just having trouble getting a grasp on the equity loan.

I am still unclear why you want to pay down the principal on an investment property when you are using it to buy your first home.

When you buy your first home you are going to need every dollar you can lay your hands on as none of the costs or expenses will be Tax Deductible.

Remember interest on a redraw will not be Tax Deductible and in fact could contaminate the deductibility on the whole loan.

I am an advocate of paying down the principal on an investment loan however suggest this strategy is not adopted when you have or are likely to have in the near future a non deductible home loan.

Cheers

Yours in Finance

Allot of people will have different views.

If it’s your first time getting into the market, education is the key. Setting up your ppor is so important from the get go.

This game is a marathon and not a sprint.

I am a believer in two things l) ensure your ppor is loan is management before you even look at buying a investment.

2) even my investment property hardly has any debt I think my lvr is 40%

Super Andrew, I disagree too regarding the PI loan on positive properties.

If anyone has non deductible debt they are basically throwing away money if they are paying PI on an investment. This is because the extra money paid is decreasing tax deductions and that money (and the tax saved) could have been used to pay down the PPOR loan sooner.Compounding this would be very costly.

Other reasons too – cashflow, save achieved with an offset, ability to buy more properties quciker etc