Investment properties and debt reduction

Crown Money, where we show you how to pay your home loan off in up to half the time of a normal bank loan. Welcome to today's episode. I'm Jesse Edge and I'm joined by our CEO Scott Parry. How you going, mate?

Very well, thank you for asking.

That's awesome. What's the weather like today?

Jeez, sunny, balmy. We've got a beautiful summer. I've got plenty of beans in the tank. I've been locked down for. For quite some time. So very keen to get out there.

You are itching to get out there, aren't you?

I'm past itching. I was itching in probably July. I'm very. I'm pumped up and ready to rock and roll.

That's awesome. It's going to be a wonderful summer, I think, for everyone. Everyone's very excited, so that's great. What should we talk about today, Scott?

What I want to talk about today is the concept, which I'm sure many of you heard and the question which burns in many people's mind is if I buy an investment property, will that help me pay my house off faster?

Yeah, great question. Because I think everyone thinks that, you know, you have to get an investment property, but they probably don't understand why and they don't understand the tax implications, what positive and negative gearing is like, all those sort of things, and how they can leverage off the property to actually pay down personal debt. And that is the goal, isn't it?

The goal is financial security. Debt free, personally, only investment debt and retiring without a mortgage.

Yeah, because you can retire with a debt against your investment property, can't you?

Well, as long as the rent's covering it, then yeah, absolutely you can, which.

Is cash flow positive.

And if you don't have the rent covering the mortgage on your investment property when you do retire, then you're going to have to top it up every single month or week, which is not ideal because it's draining your super fund. But if you're getting the capital growth, then it's not such a bad idea.

Absolutely. Or you have the option then of selling it. And that is kind of the idea. We've always said that. And I mean, it doesn't work in every situation, but if you buy an investment property, it should be for the long term. Like this is not buying it, sell it a year later, hoping to get 30% capital growth, because it's very rare for that to happen.

You're not going to get anything of the gains that you're expecting unless you hold a property for 10 years. So if you're going to buy an investment property and you're not going to hold it for 10 years, don't buy the investment property unless you're going to manufacture equity. That investment property, which is renovations, isn't it? Like renovations, subdivisions, all these different sort of ways where I can add value to this property. So if you buy a block of land and build, that's adding value to the land. If you buy any old shitty house which is running down, but you want to give it some TLC with a cosmetic facelift, such as the kitchens, bathrooms, paint, landscaping, that's adding value. If you're getting a big Corner block on 900 square meters and you can then get a council subdivision and you can split into three blocks and then you build three houses, then you can sell two of them and then one of those will be debt free and you've got a passive income for the rest of your life of $400 a week in rent or whatever it may be.

Yeah, brilliant. Which, you know. And they are a little bit hard to come by nowadays, aren't they? Everyone kind of thinks you can just go ahead and do a subdivision, but you have to make sure you understand your number. I think we covered this on a previous episode as well. Do your numbers figure it out. But that is definitely one of the options. But let's just talk about the average mum and dad family want to buy an investment property. How do they leverage off that to actually pay off their home loan?

Sure. So the only time. Well, there's two times an investment pro is going to help you pay off your house faster. One is its positive cash flow. What does that mean? That means the rent coming in is more than a mortgage repayment going out and it's paying you to own it, which is the name of the game for property. If you can be paid to own a property, how long would you keep property?

You'd keep it for as long as you like. It's an income forever. Yeah, absolutely.

Like, think of every property that you buy as a super fund.

Yeah.

And if you think of that mindset and you don't sell it until you retire, you're going to be so much more successful. Because I've never met one person out of the six and a half thousand people I've sat with who have said to me, scott, I'm so glad I sold the first property. Not one's ever said that.

Yeah, yeah. I mean, if I still had that property, it'd be worth a million dollars by now. Yeah, always. Always the case for sure.

So positive cash flow property, that's.

And there's a lot of those at the moment, isn't there?

So low. And so how do you work, what is a positive cash flow property? At rule of thumb, if your interest rate is 3%, the average rent for properties around Australia is around about four and a half percent. That's called a yield. And so four and a half percent yield, what that is is basically the rental income for the year divided by the property price. That's how you work out the yield. As long as the yield is higher than the interest rate, you're paying that positive cash. Yeah. Name of the game. Amazing. It was so rare. Never before have we had positive cash flow property. In America. Every property is always positive cash flow.

Is it true that in America their owner occupied property is tax deductible?

That is true.

How insane is that?

America's insane. Yeah, it is. Yeah. So that positive cash flow, where your rent is more than your mortgage payment, means that extra surplus is paying off your own bad debt and that helps you pay down your mortgage faster.

You got to remember that that is taxable income, though the difference, you pay tax on that. So that's just something to keep in mind. But for sure it's still an income.

Yeah. And you want to speak to your accountant. Okay. I may be the main income earner in my family. My partner is not earning as much. So therefore I want to make sure that investment, probably I buy if it's positive cash flow, is going to be my partner's name primarily. Like 90% in her name, 10% in my name, so that therefore she's not paying that tax on the income, whereas I'll be paying maximum tax on it.

Yeah.

Flip side, if it's negatively geared and you, the higher income earner out of the two, you want 90% of the property in your name, 10% in your partners. So you get 90% of that tax deduction based on the interest and the negative gear.

Yeah. So negative gear actually brings your taxable income down.

Why?

So you're paying. The difference between what you're paying on your repayments and what you're receiving in rent is a loss. And that loss can be taken off of your taxable income. So you are paying less tax. So that's the whole benefit of a negatively geared property. And a lot of people will be sold on an investment property like that because of the tax benefits. But you've got to remember you're still paying a dollar and getting 30 cents back like is that.

No. You got to be in a position where anything salty on a tax deduction run. Alarm bells, that is, you're losing money, the government feels sorry for you, therefore they're giving you some money back.

Here you go, buddy. We feel sorry for you.

That's terrific. So I know everyone thinks negative gear, negative gear. It's not as good as what it seems. You're losing a dollar, so you're negative a dollar, but you're getting 30 cents back from the tax man because they feel sorry for you, you're 70 cents down.

And what you're banking on with a negatively geared property is capital growth. So you want to say, you know, that, you know, potentially up to 10% a year in growth, which we're not getting much of nowadays.

I mean, 10% a year will probably happen for two or three years out of 10. The other two or three years it will go sideways and the other three or four will sort of slide that 5 or so percent. So bottom line, if you hold that property into retirement, you know, you're going to average that 10% over that term. You're not going to get 10% every year.

Absolutely. Do you, do you believe in the old adage that a property will double in value every 10 years?

Definitely not.

Yeah, it was such a rule. Everyone said our world property doubles in value every 10 years. But we've kind of seen now that that is not the case.

Do you know why we've hit that ceiling?

Why?

Because our incomes can't borrow or service that level of debt, which is double.

Absolutely.

And so that's the whole problem is when property prices were 200 grand, but then they doubled to 400 grand, people's income could service 400 grand. Now they've doubled to 800 grand, for example. People's income can still service it to go to 1.6 worth of debt. I just spoke to a client. $233,000 worth of gross income per year.

So much income.

So much income. He just struggled to borrow 1.5 million.

That's crazy, isn't it? On 233,001.5 million is not that expensive for a property, especially in Melbourne or Sydney or something like that. It's crazy.

So he's on $233,000 per year and struggled to get a 1.5 million dollar loan. So you can think of the average Australian out there. They're not earning 230.

No. Are they?

The price can't go from 1.5 to 3 mil because no one's income can service that level.

Do you think that because they're changing the responsible lending laws again in March and they're trying to retract what was introduced over the last few years, do you think that will. I mean, theoretically that should make it easier for people to get money, therefore they should be able to borrow more to purchase. Do you think that'll start driving the property prices up again?

Yeah. There's two things that drive property prices, demand and supply. And also rates. The lower the rate is, the more money you can borrow, because the lower your payment is, and then your income can service more debt.

Yeah.

Now, where the banks have sort of tightened the screws over the last few years is they started going through people's living expenses, like your bank statements. They should have been doing this from day one. Really?

Yeah.

But forever in a day they've said, okay, we'll say a family of a couple with two kids. Their average living expenses are X. Doesn't matter if you live in the richest suburb in your city or the poorest suburb in your city. If you're a family, that's what your average living expenses are. And so thereby you could borrow so much more if you had higher incomes, because that was the average. But we know people spend what they earn.

And this is where I'm kind of seeing so many. It's called a serviceability calculator, and every lender has one, and it calculates how much you can borrow based on your income and expenses. It's pretty straightforward. But as you said, the living expenses always used to be based on just the standard figure across the board, whereas now we have to manually calculate it based on statements based on the client situation. And so it will differ across clients. But I have a problem with this in terms of people always spend what they have access to. If you get an additional debt, like an investment property, you will naturally reduce your expenses so that you have more money available for that property. It definitely does happen that people run into trouble and they default on their loans. But more often than not, people don't. They adjust their lifestyle to meet their commitments.

The reason for that is because their loan repayment is taken out and then they live on what's left.

Yeah, exactly.

Okay, I'll live on everything, and I'll try and make a loan repayment. People prioritize their debt repayments, especially for houses, because I don't want to lose a house or the investment pro. So people will spend what they earn, which basically means people spend whatever's left after they paid their mortgage. Or their rent or their car loans or whatever it may be. And so I think the secret to money, the secret to getting ahead financially is actually making sure that you give yourself a set amount per week to live off, so you know that you're paying yourself first and then you can save the rest. Because people try and save what's left and there's too much month left at the end of the income.

I think as well, people have got to realize that if you go for a home loan nowadays, the banks are going to go through every single one of your statements, every single one of your liabilities, everything with a fine tooth comb. I mean, I've done that myself with assessed deals. And we will literally go through your savings statements, your transaction statements, line, line by line, and we have to question every single thing that doesn't look normal or is a bit out of sorts. I mean, so many times we'll see transactions that may seem harmless, but because there's a repetition to them, or too many lotto purchases. This is a weird one. You've got a couple of lotto purchases a week. That can be considered gambling and that can be a black mark against your application. It is hardcore nowadays, I think if you're going to apply for a loan, you're thinking about purchasing or buying an investment, investment property, you've got to think to yourself, I've got to keep my statements clean for at least a month, but preferably three months. Really, it needs to be, you know, just really clean living. Clean living.

Act as if you've already got the property. It's really qualitative for three months. This is, I mean, to the point of crazy. You can borrow less if you send your kids to private school than public school.

Yeah, well, and that's because. So public school, obviously you don't have to outlay very much, so that's included in what they consider the base living expenses. Whereas private school is, you know, a fixed additional cost which is quite high, which they will factor into your service. It's a liability, basically, a debt that you've committed to.

I've also seen people get declined because they were taking money out of ATMs at the Crown Casino to go for dinner.

Yeah, that was a good one. And we actually had a client that worked at the Crown Casino and so he had all these Crown Casino transactions and the bank was like, well, clearly they're a gambler and they actually worked. We had to cut a very detailed.

Explain it to them.

Why?

That's just where he gets his cash out of the atm, because it's closest to where he works.

But they will, they absolutely go through all your statements. There's technology, AI technology now that will, you know, scan your statements for certain patterns and what they, you know, they're looking for. What are you actually spending? So I think, you know, you've got to keep in mind that this is going to happen. You know, this is why people trying to borrow in January, it's always a lot harder because their expenses over November and December are always so high. So the bank goes, well, this must be your expenses. But no, that was just their expenses for that month. When you look over the 12 months, it's actually much less. But that's just. Yeah, something to keep in mind if you're going to borrow, keep your statements really clean for three months.

Now, with this investment property purchase, positive cash flow, it's going to help me pay off my mortgage faster. Negative cash flow, negative gear. It's going to obviously slow down your mortgage reduction. What we also want to take into account is the way that Investment Pro is structured. So I've just spoken to another client yesterday who was saying, hey, I've got my Investment Pro, got my home, I'm paying, basically going to retire in six years. My Investment Pro is on principal and interest. And I said, why is that? He goes, well, I had it on interest only, but then the five years expired. Now it's gone to principal interest payments. I said, whoa, whoa, whoa. First and foremost, we need to get that back onto interest only because you're paying an extra $500 per month off your investment property when that final per month should be paid off your home. On your bad deb, you're affecting the tax deductibility of your investment interest because you're reducing that debt, whereas you should be reducing your bad debt, which you get no tax benefits.

Always if you have any debt against your own home, and particularly if you had any like credit card debt or personal loans or anything like that, you've got to get that debt out of your life first. Anything that's attached to an investment or an investment property has tax implications. Don't touch that debt. You want to keep that debt as high as possible. And that's a great example. What does a client do once their interest only period expires?

Yeah, well, this is a big problem for a lot of people where they just weren't in a position to refinance.

Because that's the ticket, isn't it? You got to refinance.

Yeah. The same lender won't extend if they give you a five year interest only period for your investment property and it expires, they won't go, oh, here's another five years, go get a target for 30 years. They want a loan paid off. And so that means for the next, you've had interest only for five years on a 30 year loan for the next 25 years. That's principal interest payments which are higher. To make sure that debt is exterminated within 30 years. However, you need to be refinancing as long as you're in a position to back onto another five year interest only period. If you've still got bad debt, home loan, car loan, personal loan, credit card debt, you want to make sure that all your personal debt is paid off before you start paying off any investment debt.

Absolutely. Yep. That's the number one rule of thumb. And so a lot of people will retire with debt still against their investment property. And that's okay. Like we discussed at the beginning, there are options there, but you know, your primary focus should always be, I need to be completely clear of personal debt.

By the time you retire.

Yeah.

So you're not cannibalizing your super fund to pay off your home loan. Fair enough. If you want to cannibalize your suit fund to pay off your investment property, because that's going to spin off a passive income. Plus you can always sell the investment property and take a big chunk of equity from the sale. But if you're in a position where you are retiring with a mortgage, your lifestyle in retirement is going to be decimated compared to what it would be if you didn't have a mortgage.

Absolutely. Now the other thing I wanted to talk about in regards to investment properties is just going back to the structure. And so we've talked about always paying down personal debt first. There's another term that I want to talk about and it's cross collateralization. So some people will secure their owner occupied property and their investment property together. And so what you do is you, when you submit your application to the lender, both properties are submitted as security and you get one giant loan for both debts. And it's just usually has two splits. An owner occupied split, investment split. Now this is a pretty common practice and it's definitely happened in the past, but I just want to talk about the risks or the problems with doing that. If you cross securitize properties. If you sell one of those properties, you have to do what's called a partial discharge. In a partial discharge, the lender will look at the remaining property and the remaining debt. And sometimes, to be perfectly frank, you get screwed with your pants on. You've got to be really careful. If one of the property drops in value, you may be required to pay back more than what you thought you owed on that investment property. It's definitely a great idea, if you can, to structure it as two completely separate loans that aren't cross collateralized. You can do this with the one lender you don't have to go to, necessarily two separate lenders, but it must be two separate application forms. If you're ever speaking to a broker or bank, make sure you say, I do not want these cross collateralized. They can submit them as two different deals and pull equity from one property if they need to to top up the second property. Now you may end up with three, like two loans with three different splits. So it may be a little bit more confusing, but I can guarantee you in the long run it's going to be the better solution.

So how that looks is you've got your home loan, let's call it a 300 grand home loan. You've got a $600,000 house, then you want to buy an investment property for 500 grand. You need a 20% deposit plus stamp duty, so that's called 125 grand. So you'd have your 300 grand home loan, then you'd have a separate loan split secured by your home loan for 125 grand. And then you'd borrow 400 grand in a separate loan for your investment property. So there's no mortgage insurance. They're not cross collateralized, they're totally separate. But you have two splits for your home. One is owner occupied debt. The 125 grand is investment debt, fully tax deductible, separate statement every single month. And then you've got your 400 grand investment property, which is obviously interest only. And that one 25 grand is interest only as well.

Yeah, because you can choose what products you want. It doesn't have to be P and I because it's attached to an owner occupied property at all. In fact, some lenders will give you a cheaper rate on that 125,000 because it is secured by owner occupied debt, even though it's still interest only. So something to think about. And I think a lot of people may complain that it's a bit confusing nowadays the more splits you have. And I get that we like things to be simple and straightforward and clear, but when it comes down to if it's worth money to you, you just got to do it. And just be very clear from the beginning if you can name your loan splits on your Internet banking, name them with investment property deposit or the investment property address if you've got more than one property. And be very clear, if you've got a great accountant, and you always should have a great accountant, when you make a purchase, you could email your accountant and say, hey, just letting you know I've set up these financial structures in regards to this investment purchase. He'll put it away in your file and bring it up again at tax time.

Beautiful.

Awesome. Thanks, Scott. We'll speak to you again soon.