How to tackle more than one mortgage
Taking on a mortgage means taking control of your finances. Adding an investment property to your loan portfolio requires additional discipline and planning. With interest rates lingering at record lows, it’s important those taking on another mortgage look beyond the here and now and invest in some long-term thinking.
Positive or negative?
Positive gearing means your investment property income covers all the associated costs, including your mortgage payments and upkeep costs, such as rates and repairs. Negative gearing is when you have a shortfall between the rental return and the cost of owning the property. You may be able to claim the difference as a loss on your tax return, reducing your taxable income. However, it is wise to speak to your accountant or financial planner to check your personal situation. Note, however, when it comes to loan repayments, you can only claim the shortfall between your rental income and interest charges. You are not allowed to claim any repayments on your principal.
Many Australians opt to negative gear to take advantage of the tax deduction but don’t let this be your single guiding factor. Long-term capital gain that adds to your personal wealth should still be your ultimate investment goal.
If you decide to negative gear, make sure you budget for interest rate increases, which will stretch the loan gap you have to cover, and have funds in reserve to offset any lapses in rent.
On the flip side, a positively geared property may deliver a high rental yield but could lag in capital gain, especially if an apartment in a high-density location. Similarly, make sure you have ample funds to cover any tenant vacancies (it is easy to be lulled into false financial security when your tenant takes care of your mortgage) and be prepared for interest rate hikes.
Regardless of whether you gear positively or negatively, research is critical. Look at the location’s annual vacancy rates, average rental yields and historical and predicted property values.
New vs used
The last federal budget1 restricted what property investors could claim for depreciation on fittings and fixtures in established properties, such as air conditioning, ovens and ceiling fans. In other words, you could once claim depreciation on renovations undertaken by previous owners. Now investors can only claim depreciation on equipment they have bought themselves. The new rules mean new properties are more attractive from a depreciation perspective, with many investors banking on this tax loop to help cover their loan repayments for the first several years. However, depreciation is only part of the financial equation and should be balanced against the property’s long-term potential for rental return and capital growth. Investors need to make sure they have the means to cover their mortgage for when the depreciation write-off dries up.
Be sure to speak to your tax advisor before you purchase an investment property to understand fully how the new depreciation rules and other tax laws impact your finances and ability to afford your loan repayments.
Applying for another loan
Investment lending has tightened in Australia in recent years to help cool the property market and to reduce the risk of over-borrowing and loan defaults. Investment loans now incur higher interest charges and may also require a bigger down payment to lower the loan-to-value ratio (LVR).
Most investors rely on an accumulation of equity in their own home to cover the deposit and purchasing costs (stamp duty, conveyancing etc) on their first investment property but lenders are now being asked to be more scrupulous when it comes to affordability. As with any loan, you will be asked to demonstrate you have sufficient income to cover the investment repayments, including a reliable rental return.
Many investors opt for interest-only loans, which means you are not covering any of the principal owed. While this reduces your loan repayments, you will not be paying off the property. Rather, you are relying on the property increasing in value by the time you decide to sell to eventually pay off the loan. While this long-term strategy can reap rewards, it is vital an interest-only loan is the right fit for your individual circumstances – you do not want to be incurring additional interest costs if there is no need. The Australian Prudential Regulation Authority (APRA) is also asking lenders to clamp down on interest-only loans so stringent assessment conditions are in place.
Talk to us to help source an investment loan that is right for your circumstances. As a broker I bring choice to the table, and with access to loans from multiple lenders and up-to-date knowledge of lending rules, can take the pain out of navigating what is an ever-changing and increasingly complex landscape for property investors.
Keep them separated
One of the biggest mistakes first-time property investors make is blurring their private and investment finances by dipping into their investment loan to cover personal costs. The aim is to leverage your personal finances to improve your investment potential and build wealth. While a redraw facility on a home loan is practical, it can create complexities on an investment loan, especially if you are drawing funds for personal use rather an investment property expenses. Remember, only the interest charges on your investment loan are tax deductible. If you start using your investment loan for personal uses, tax time will be messy and you are likely to attract the attention of the ATO. Importantly, you are also eroding your investment strategy, which is to get ahead financially.
We can help set up the right loan facilities for both your mortgage and your investment loan to ensure each supports your cashflow requirements and investment goals.
Tax: the information in this article does not constitute advice. As taxation legislation is complex we recommend you speak with your financial advisor, tax advisor or contact the ATO for further details and expert advice regarding your personal circumstances.