This year coming to an end, we have been discussing ways of increasing your wealth through investment properties, and effective ways of structuring your finances.

Coming into the new year, the average family tends to overspend, and paint themselves into a tight corner. It is quite normal to see several properties come onto the market within the first two months of the year, which are priced to sell quickly.

The present state of the property market is not all doom and gloom. There are many opportunities that are there for the taking, just because of the way the market is.

And of course, there is always those areas of growth that still chugs away unnoticed by mainstream investors, largely so because most have not relooked at their investment strategies with the slower market.

Naturally, as the market slows, fewer and fewer new investors buy property, and fewer developers build, as they see this as high risk. As there are less rental properties available, demand for rentals goes up, along with the rent, which increases your return. This combined with developers and vendors ready to discount their properties to get a quick sale is great for the would be investor, and indeed the first home buyer.

The crux is getting your financing right so that you are able to ride the potentially slower periods and dropping values using the equity that you have built up in your existing properties.

The other thing that you must do is ensure that all your safety nets, in terms of mortgage protection, and income protection insurance, is in place so that you are well covered should the unexpected happen.

If you do not have these safety nets in place, or are looking at investing or even buying your new home, give me a call on 1300 302 166 for a quick chat.

Financing an investment property purchase is relatively straight forward, yet most first time investors get it wrong, leading to inflexibility later down the track, and added costs when buying another property. There is also the matter of putting your own home at risk (refer to my previous article).

I am going to make a couple of assumptions here, one being that you have sufficient equity in your existing home to complete the purchase as two separate loans. Often people are sold on the idea that the lender or broker will get the 105% or more of the purchase price so that there is no cash outlay by them, and to achieve this, they place both properties (their home and investment property) as security with the same bank.

The exact same thing can be achieved using two separate lenders, and depending on the equity available in the existing property, mortgage insurance payments can be avoided.

The idea is to increase your existing loan with the present lender if they have a good product to cover for a 20% deposit and your closing costs (stamp duty etc), taking care to keep this money separated from your existing balance for taxation purposes.

The balance of the funds should be sought from a separate lender, as a separate loan secured by the property being purchased. For ease of management, a direct debit should be set up from your loan on the home or first property, so that you don’t have to remember to make the payment each month, it happens automatically.

The only time one should look at going back to the same lender and putting the two properties together is when there is not enough equity to do this separately, being very clear with the risks associated, in the immediate term to your home, and on the long term to your wealth accumulation plan.

 When buying an investment property, people invariably start looking for a property before they have their finance in place. This is a classic case of putting the cart before the horse.

People often get burnt quite badly because of this simple oversight.

Why should you have finance in place beforehand?

The reason is quite simple: will the lender lend you the money in the first place? It is no sense exchanging on contracts, and then attempting to get finance in place, as you (or your broker) will be scrambling to put it in place, and there is no room for negotiations or correct restructuring of existing mortgages.

What invariably happens is that time is of essence, and the investor is swayed and indeed overwhelmed by the myriad of paperwork that needs to be filled out, and invariably ends up cross-collaterising the properties.

Cross Collaterising can cost you big later down the track.

Whilst sometimes this cannot be avoided, cross collaterisation is certainly lethal to your long-term financial health.

Cross collaterisation means putting both properties under the one loan, albeit with different splits. The way this is sold to the investor is that they will be able to save on the application fee, and may get an interest rate discount, and indeed, they will be able to get one hundred percent finance.

Lets look at the downside:

1.    There is an all monies clause on the mortgage documents. What this means is that if you default (and sometimes even if you are not in default), the bank can call on ALL the monies owing, i.e. your home loan and investment loan.

2.    If you are late on repayments, then the interest rate jumps by as much as three percent on ALL the money owed, so you go into a steeper spiral, making it harder to recover financially.

3.    Your home has the higher equity, and if you fall onto hard times and are not able to meet your obligations, guess which property the banks going to sell off first?

4.    Your borrowing capacity is diminished, and indeed, in most cases, because all the loans are with the same lender, you are able to borrow less money from the start. Lenders “load” the interest rate by up to 3% when assessing your repayment capacity.

5.    You end up paying more mortgage stamp duty (this is the stamp duty you pay every time you borrow money) I will elaborate on this in the next article.

So whats the upside?

Often, when there isn’t sufficient equity in your present home, by putting the two properties together, you are able to purchase the property.

You may also save on a second application fee, being that there is only one application done.

It is quite obvious that the disadvantages far outweigh the advantages when you cross collaterise the properties.

In the next article, I will discuss the correct way to finance an investment property purchase.

 Property provides three things:

1.    Growth
2.    Income
3.    Risk

It is very rare to find all three attributes in the one property, and indeed, usually you have to choose the best two out of the three.

Lets say you wanted a high degree of growth, with lower risk. Obviously you would then have to sacrifice on the income side of things .A typical example of this would be say a property in say, Baulkham Hills, Sydney. A couple of years ago, research had indicated fairly strong growth, especially with the changing demographics in the area. The rental return, however, was far lower than a property bought in say Liverpool, as the prices were lower in this area in comparison. Buying in Baulkham Hills assured that you would get the growth, with lower risk, but you sacrificed the income. I.e your holding costs were higher. ( Note, I am not advocating that you go out and buy in these areas, as these may not suit your particular circumstances, and I have used these areas merely to illustrate a point).

Another way of looking at the above is to understand that this is a negative cash flow property. In other words, it is costing you money out of your pocket to hold this, while you wait for capital growth to happen. Therefore, the research of the area is absolutely crucial, to ensure that the money you outlay is outstripped significantly by the capital growth that you will experience in the property.

Another way of investing in property is to buy one where the income is higher than all your outgoings, in other words, the property is putting money IN your pocket on a weekly basis after all your mortgage and associated payments. And you guessed it; you are either sacrificing growth, or taking a higher risk. Such properties can be located usually in mining  or regional towns.

Obviously, if you are looking at buying in these areas, you need to do quite a bit of research to ensure that the area does not “close down” on you if it is dependant on just the one industry. An example of this would be investment properties bought in Forbes, NSW, where when the abattoir closed, people started moving away in droves in search of jobs, which resulted in a lot of vacant properties, and plunging prices, a very good illustration of the risk you face when investing in these sort of areas without doing proper research.

It is rare, but not impossible, to find investment properties where all three aspects are perfect, i.e. the property has growth, has positive cash flow (income) and low risk.

When investing in property, it is imperative that you look at what you want to achieve before starting to look for a property.

Victor Kumar specializes in helping property investors set up finance strategies to invest safely and successfully. To contact him, call 1300 302 166 or visit www.rightgroup.biz.