As Gold Coast lawyers, we are aware that Lenders have a significant advantage when negotiating with property buyers. These finance tips for property buyers will help you to prepare yourself before you engage with your Lender.
1. The Basics You Already Know
The following information is of a general nature and may not be applicable for your circumstances
- Keep separate financial records for every property
- Keep your financial records organised so you can act quickly when an opportunity or threat arises
- Know which debt is deductible & which is not deductible and don’t mix or contaminate the loans
- Ensure that all non-deductible debt is repaid first before paying deductible debt
- Have surplus or contingency funds available for unforseen events affecting you or the property
- Understand when to have an ‘interest only’ loan instead of a ‘principal & interest’ loan
2. Assess Your Financial IQ
- No matter how informed you may be, it can be worthwhile to obtain a second opinion from an independent experienced professional.
- Whilst property buyers receive information from real estate agents and bank staff, their primary objective is to sell their products rather than provide you with advice or information.
- The real estate industry and banking industry distribute high volumes of information, and it is not always easy for you to determine what information is relevant.
3. Advice from Banks
- Whilst many bank staff are helpful, they do not provide financial advice and are unable to tell you what is the best product in the marketplace.
- Bank staff sell their own loans, which may or may not be what you need. Even if the bank has the right product for you, they cannot provide you with the additional advice and service that you need.
4. Quality Finance Broker
- A quality finance broker (mortgage broker) will try to secure for property buyers the best financial product in the most appropriate structure for their circumstances.
- The best loan arrangements will minimise the buyer’s loan expenses and maximise their financial position for their short and long-term benefit.
- If you don’t have a finance broker, we can provide you with several options.
A quality finance broker will:
- Review your existing loans to determine your current circumstances
- Discuss your current and future plans and requirements for finance
- re-structure your existing loans as necessary
- identify which lenders have the best products most suitable for your circumstances
- assist you in preparing your loan application
- structure any new loans to suit your circumstances
- ensure the lowest interest rate or most suitable product!
5. Don’t Borrow To Your Limit!
- A common mistake of buyers is to spend all of their finances on the purchase, repair and upgrade of a property!
- You should always have an amount of money set aside & available to use as a contingency fund in an emergency.
- You should discuss with a financial advisor the amount of money you should have in the contingency fund, perhaps a percentage of the loan amount.
- Further information is provided below about some examples of where the contingency funds can be held – such as a offset account or line of credit account.
6. Pay Off Your Home Loan First
- Where you have a loan for an investment property AND another loan for the home you live in, obtain financial advice as to whether you should pay off the home loan first.
- Australian taxation laws currently allow many taxpayers to claim deductions for expenses for investment properties rented to the public.
- As there may not be such benefits for loans for the purchase of the home you live in, obtain advice as to which loans to repay first.
- Where a loan secured by your home is used for investment purposes, the loan costs may be a deductible expense.
Where your advisor recommends paying your home loan first:
- As you want to make the highest possible payments off your home loan, the investment loan payments need to be as low as possible.
- The investment loan should be interest only where the monthly payments only pay the interest and no debt repayments are made.
- The home loan should be principal and interest, with each payment as high as borrowers can afford to reduce the principal debt as quickly as possible.
7. Keep Property Loans Separate
- Where you own multiple properties, it can be beneficial to keep your financial arrangements as separate as possible.
- Rather than using the same Lender for multiple properties, use different lenders for different properties.
- Avoid giving a bank a mortgage over more than one property to secure one loan. You need a separate loan agreement for every property; and better to use different lenders for different properties.
Consider this example:
- You have a small mortgage over your home with the ABC Bank and you wish to use the equity to finance an investment purchase.
- Arrange an investment loan over your home with the ABC Bank. Keep the amount borrowed below the maximum LVR to avoid mortgage insurance.
- This investment loan on your home will be used as a part payment for the purchase price of the investment property.
- Arrange an investment loan and mortgage from the XYZ Bank to purchase the Investment property.
- Whilst this process requires more work for you, it is absolutely critical as the properties and the loans remain separate. The failure to adhere to this process has destroyed many people’s finances.
8. Fixed or Variable Interest Rate
- Whilst borrowers should obtain advice, noone knows the future for interest rates.
- Advantages to a borrower of a fixed rate loan:
- certainty as to the loan repayments for the term of the fixed rate loan
- protection against future increases in interest rates for the term of the fixed rate loan
- Disadvantages to a borrower of a fixed rate loan:
- no reduced loan repayments where the interest rate drops for a variable rate loan
- unable to make additional payments to reduce the debt for the term of the fixed rate loan
9. Splitting Your Loan
- When borrowing an amount of money secured against one property, you can enquire as to whether it is possible to split the loan into 2 or more parts. For example, one part could be a fixed interest rate loan and the other part could be a variable rate loan.
- The fixed rate loan gives you protection from interest rate rises for that part of the loan.
- The variable rate loan gives you the benefits of:
- lower interest payments for that part of the loan where the variable interest rate drops
- the flexibility to make additional debt reduction repayments where surplus funds are available
- Before taking out the loan, the borrower decides how much will be fixed and how much variable.
10. Establish A Contingency Fund
- Where available from your Lender, establishing a bank account to place your surplus funds or contingency funds can be a useful component in any risk management plan for property owners.
- These funds are immediately available when an emergency arises, but the funds are put to the most effective use possible in the meantime by reducing the interest charges for the loan.
- The funds are held in a bank account described as a Loan Offset Account or a Line of Credit Account, and this account is linked to the loan account.
- Where you are unable to plus sufficient funds into the contingency fund account at the time of the purchase or refinance, you can increase these funds over time.
11. How Contingency Funds Help
- The loan account balance is reduced by the daily balance of the contingency fund, which reduces the monthly interest bill for the loan account.
- If your loan account balance is $400,000 and you have $20,000 in your contingency account, then interest is only calculated on $380,000.
- Therefore the funds are put to the best possible use at all times, and are immediately available when an emergency arises. The $20,000 is available for you to withdraw if some unforseen event occurs.
- You do not want to repay the $20,000 off the Loan Account as you will not be able to easily access that money should an emergency arise!
12. Increase Contingency Funds
- Where you structure the loan correctly, one way to build up your contingency fund is for the loan to be Interest-Only for the first year.
Example for a $400,000 loan:
- A Principal & Interest loan @ 6.5% means that in the first year you pay $26,000 interest payments PLUS debt reduction payments.
- An Interest-Only loan @ 6.5% means that in the first year you pay $26,000 interest, and NO debt reduction payments.
Suggested strategy using an Interest-Only loan:
- Each month, pay an amount equivalent to a principal and interest repayment, however:
- the debt reduction payment component is deposited to the contingency fund, &
- the interest payment component is deposited to the loan account.
13. Additional Loan Payments
- Whilst additional loan payments can be worthwhile, you must confirm with the Lender that additional payments are permissible and that there will be no costs, charges or penalties imposed for the extra payments.
- A small increase in the monthly payment can have a significant impact on reducing the length of the loan and the amount of interest paid to the bank:
- Referring to the Principal & Interest loan example above where a $400,000 loan had interest payments of $26,000 per year and debt repayments of $6,000 per year >>
- The monthly principal & interest payment is $2,167 interest plus the debt reduction payment.
- What if the monthly payment was increased by $100 ? An extra $100 may appear insignificant, however, every dollar in excess of $2,167 each month is where debt reduction occurs.
- Where interest rates are reduced and therefore the minimum monthly loan repayment is reduced, the loan payments should be kept at the same level:
- Referring to the Principal & Interest loan example above, where the interest payment reduces $40 to $2,127, the borrower should continue to pay $2,167 each month plus the debt reduction payment.
- The additional $40 component is applied to the reduction of the debt, which reduces the term of the loan and the total interest costs.
- By keeping the monthly payment the same, in this example, you are increasing your debt reduction by $40 each month.
14. Risk Management
Some risk management strategies worth mentioning:
Personal Insurance to provide financial protection for illness, accident, disability or death:
- The likelihood of an unwanted event during your working life is more probable than you think. Where your capacity to earn income is affected, your financial plans can quickly unravel due to the forced sale of property.
- You need to be financially secure when an unwanted event occurs, as it does every day to far too many unprepared Australians. Such insurance is mandatory in some countries
Title Insurance provides protection where an issue arises which affects your ownership, use or enjoyment of the property. Such insurance is mandatory in some countries.