Thomasp, I borrowed 80% from BankWest. The info I had was that the LVR is limited for expats because the lenders cannot get LMI.

Det,

Interest rate rises will be a problem for you if:
– Your loan payments rise beyond your means forcing you to sell, or
– High interest payments erode the profitability of your investment, or
– High interest rates lower the value of your property when you want to sell.
One way to manage the first two points would be to fix your interest rate.
Regarding the third point, your investment time-frame is probably considerably longer than that of any currently expected interest rate rise. If you’re looking at holding the properties for 10 years or more no-one can forecast what interest rates will be doing at that time. So the only effect of short-term rate changes is that there might be an opportunity cost, meaning that you could have bought your investment at an even better price. With the equity you have one option would be to make an investment now and keep enough available to make another, better, investment later if the opportunity arises. What you learn with the initial investment may help you to spot that opportunity!?

I don’t think you’ll get any argument that the market sentiment has changed. Going back a few years making a bad investment might have resulted in only making a small profit, now it could result in a large loss. That doesn’t mean that profitable deals don’t exist right now, but evaluate each opportunity on its own merits and don’t rush in unless the numbers look good to you.

That’s how I would look at it anyway!

Great thread foundation…

From an investor’s point of view wouldn’t you say that population growth is still an important driver for capital gains? Sure, you show that demand is continually being met by new supply so it may be reasonable to conclude that it is unlikely for median prices over a whole city to be impacted. But if the population grows by, say, 20% then isn’t that 20% more people who aspire to a nice house on a good-size block of land in a harbour-side suburb within 15min of the Sydney CBD? There is no increase in supply of such properties.

So, as an investor, as long as you’ve chosen your properties well you can expect growth in the value of your portfolio to be driven by population growth.

I guess my point is even if you have busted a myth, isn’t it an error in generalisation rather than in substance? OK, median prices may not be affected by population growth, but an investment portfolio is and that’s what we care about?

With $70,000…

If you pay down debt at say 7% interest you make a guaranteed $4,900 per year.

Based on your given assumptions the shares don’t look attractive enough given that these returns are *not* guaranteed. BUT, what you really need to do (IMHO) is look at the range of possibilities – what is the outcome in the worst-case scenario assumptions and what is the outcome in the best-case scenario assumptions. This gives you an idea of the risk/return profile.

By paying off the debt you won’t do worse than your current interest rate but you also won’t do any better. By investing in a growth asset like shares or another IP there is certainly a risk of doing worse but there might be a possibility of doing much better. Based on your own goals and situation you need to decide whether the possible returns make the risk worthwhile. (And you need to evaluate the risk in the context of your own personal circumstances, a worst-case negative cash-flow might be an inconvenience to someone on a large salary income but a disaster to someone who is forced to sell assets at the bottom of the market in order to service debt.)

The IP is similar to shares, you have to look at a range of scenarios for capital growth/rental growth/interest rates etc. to see what you expect the best/worst outcomes to be. Of course as you’ll be using a lot of leverage that is going to multiply the possible gains/losses so the best case scenario is likely to be considerably better than paying off debt over the long term and the worst case scenario is likely to be significantly worse.

Keep in mind that returns from growth assets like shares or IP are compounding, so they might look like marginal investments in the first year but over the years they do increasingly better than the fixed interest return. You could of course invest your increased cashflow (from paying off the debt) elsewhere but even that’s disadvantageous because you have to pay tax on the cash each year whereas in the compounding growth assets you are deferring tax until you sell.

Your thoughts on the future performance of your existing IP aren’t really relevant to this decision. You are planning to keep that property regardless of what you use the $70k for so you’ll get the benefits of futher capital gains/rent increase on that property regardless.

Some assumptions I would challenge:
– Shares with 13% capital gain in the first year then nothing. If you’re buying shares you should be looking at a 5yr+ horizon and for a balanced portfolio you would probably expect some ongoing growth in the long-term. Your assumption is equivalent to average 2.5% growth p.a. over five years which is pretty conservative.
– You don’t assume any growth in dividends, but it might be more realistic to expect dividends to grow as the company grows.

Your decision to pay off debt might still turn out to be the best option for you, especially if you are bullish on both the property and share market, but it looks to me like you could afford to do some more scenario modelling?

You have to take into account additional closing costs (stamp duty, solicitors fees, bank loan fees and LMI, etc.) as well as the deposit. Stamp duty is the big one and is different from state-to-state. You can find calculators on the web to estimate these costs for you (major bank websites?), for my (one) property in VIC the total was around 6-7% of the purchase price.

As for a solid starting base, some thoughts…
You need to consider your own circumstances and examine the downside. How much do you think interest rates could go up in the next 5 years (worst case) and would you be forced to sell if that happened? If yes then perhaps you don’t have a solid enough base! Depends on how much you’re willing to lose I guess, but being forced to sell when the market is low is the biggest downside I see.
How secure is your salary income? If you put all your savings into property then you (possibly) no longer have a safety net against loss of earnings, how fast can you make extra payments against your loan to build that safety net back up?
If you decide to buy a property to live in then compare the mortgage repayments to your current rent, also compare your rent against your payments with theoretical maximum interest over the next 5 years, how much additional pressure would this put on you? In my case my repayments after I bought were less than my rent, but that’s because I moved from renting in the inner suburbs to buying in the outer suburbs.

Maybe this is a dumb question. But does Michael have to beat 6.5% (the interest rate on his mortgage) or 12.6% (the rate pre-tax assuming he’s in the top tax bracket and paying Medicare levy) given that money borrowed to purchase his PPOR is not tax-deductible?

Are you saying he can borrow money to buy fixed interest securities (f/ Eurofinance) using his PPOR as security and still claim the interest as a tax deduction?

It amazes, even frightens, me how much debt first home buyers in particular and young Australians in general are willing to take on.

My wife and I decided to buy our first home 2.5 years ago. We were renting in inner-suburban Melbourne at the time but despite being very fortunate to have salary income comfortably in the top quartile for Australia we decided to move to outer-suburban Melbourne to buy a property. We simply weren’t comfortable with carrying the amount of debt required to purchase a property in the area where we were renting.

By contrast my brother and his girlfiend, with joint income perhaps around the median, bought a house a few months later in inner-suburban Melbourne. It’s about half the size of ours but cost the same. So they are servicing the same debt (an amount I considered to be about the maximum that is comfortable for me) on half the income. Somebody’s reality is out of whack, I don’t know for sure whose but I hope it works out for them!

(Both properties were less than the median price at the time.)

Very few of my friends (I’ve just turned 30) have bought a property yet, maybe 1 in 5 have. I don’t know of any of my peers who’ve bought something in the $350k – $400k range, but perhaps not far short of it. But still, it certainly doesn’t surprise me that people are willing to do that, I think saving the deposit is a bigger barrier than servicing the debt in most people’s mind.

The consumer society we live in is amazing. A friend of ours recently returned from living OS for several years and the first thing she did (in the first week back!) was buy a new car fully financed. She spent more money on a car than I did, she funded it through debt, and based on her occupation I expect her earnings are somewhat less than AWE. I find that astounding but it seems that I’m in the minority, that kind of need for instant gratification and lack of concern about taking on “bad” debt seems to be the majority position. I must be weird? Thoughts?