Tuesday, 7 August 2012

Funding Property Deposits

If you are reading this then you have most likely made up the decision to at least look at investing in property. And why wouldn’t you, investing in property should be easy right? Purchase a house, put some tenants in, hopefully the rent collected would cover all your expenses and pay the home off. Few years later, capital appreciation has increased the value of your asset and you have made yourself a tidy profit without having to do much at all, money for nothing, as ZZ Top might say.

But the most important part of property investing is the actual purchase of a property. Buying a property at a good price can be the difference between a great investment and a terrible investment. Buying your first property, whether for investment purposes or otherwise, is typically the most difficult. With rising house prices all over Australia, affordability has decreased dramatically and has left a lot of first home buyers with no hope of being able to enter the property market. The first step is getting the required deposit. I am a firm believer in trying to minimize your finance as much as possible. I am not saying that you should avoid finance all together, because I am sure most of you do not have $400,000 lying around to be able to purchase a property outright, so of course you will have to use some finance to be able to fund your dreams. But even if you are buying with someone else’s money, there still comes the difficult part of having to find enough money for a deposit for the property. Gone are the days where you can purchase a property with no money down, obtain a mortgage of 105% of the purchase price to be able to cover all the fees associated with purchasing. This means that we are left with no option but to obtain finance, and in my opinion I would generally try and aim for a LVR of 80% maximum, not only are you able to avoid LMI (Lender’s Mortgage Insurance) but it should also protect you against a negative equity situation and provide a more sustainable mortgage.

But then the question still remains how you can come up with the 20% plus purchasing costs required. For a $400,000 property, that would be $80,000 plus purchasing costs of around $10,000. A total of approximately $90,000, and again I am sure most of you do not simply have this money lying around. So what is the answer? Well I think I will disappoint you because unfortunately my solution is not very exciting. Save, pure and simple, just keep saving up money until you have enough money to comfortably enter the property market. If you are a first home buyer, the government offers a “First Home Buyer’s Account” which means interest earned on your savings is not only tax deductible, but also receives additional government contributions added on top of your savings. There are of course some regulations associated with this account which I will not go into here, if you want a full list of the information for this account, please see this link – First Home Buyers Account.

So what are the benefits of saving, well first of all you will have a much lower financed amount which will mean you will end up paying a whole lot less over time. See below for some numbers to put things into perspective –

Situation A – $350,000 loan with 7.00% interest with a monthly repayment of $2,500 will take 24 years to pay off. Total cost of $720,000 + $50,000 deposit = $770,000

Situation B - $300,000 loan with 7.00% interest with a monthly repayment of $2,500 will take 17 years to pay off. Total cost of $510,000 + $100,000 deposit = $610,000

So as you can see, even though you may take an extra 5 years to save up the extra $50,000 deposit, you will still end up owning the house faster and paying $160,000 less. This is a very simplified example which does not take into account a lot of variables such as capital appreciation of the asset, rent money required while not living in your mortgaged house, and several other variables. But the main point you need to take out of this is the power that having a sizeable deposit can have on your overall loan term, and the overall return you can make.

Once you do own your first property, you will find it much easier to be able to fund future deposits, because provided you did have a good sized deposit, you should be able to discuss with your lender about accessing equity in your property which you can use as a deposit for future properties. For example, if you purchase a property valued at $400,000 with a finance amount of $300,000, you have access to $100,000 in equity which you can use for further deposits. In one year’s time, if the property value has increased to $420,000 (5% increase), then you would have access to potentially $120,000 in equity. You would need to discuss this with your lender as they would typically not allow you to access ALL of the equity you may have in a property, and a more realistic assumption would probably be the lender would allow you to use up to 80% of the equity available in your property.

Using equity is probably the easiest way to be able to fund property deposits, and one of the best things you can do is to be able to purchase a property below value and then you have access to instant equity. For instance, if you purchase a property for $200,000 and the bank has it valued at $220,000, well then you already have access to potentially $20,000 in equity and you have not had to wait for any capital appreciation. Other ways to increase the equity available to you is to force the property value to increase, such as by performing renovations and the like. Both these methods can allow you to access equity a lot quicker, without having to wait for it to grow naturally like you would with capital appreciation.

The only potential issue with using equity is that you are essentially borrowing 100% of the property value for your new purchase, this would increase your LVR and your lender would start looking at your ability to service the loan before it instantly allows you access to the equity.

There are countless ways to be able to fund property deposits, but I hope I have outlined the most common ways, and unfortunately they may not be the most adventurous ways but they are proven to work and nobody ever went broke by saving a dollar.

If you have any questions or comments feel free to email us at streamlineinvesting@gmail.com

Disclosure: The article is not to be taken as investment advice and the views expressed are opinions only. Readers should seek advice from someone who claims to be qualified before considering allocating capital in any investment.

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