Mortgages – The Great Juggling Act

Owning one’s home has long been a staple in the great Australian dream. Meanwhile, buying an investment property has also been seen as the next step in this ever elusive reverie; but it may not come as easily as buying the family home. An investment property brings with it its own set of challenges and obstacles and can make one’s finances resemble a torch-juggling act that can easily catch on fire if the proper precautions are not set in place.

Staying on top of two mortgages requires a planned approach and this begins with your choice of investment property. Deciding between a positively geared and negatively geared property can make a lot of difference between your repayments and tax benefits. You should also consider choosing a property with potential for capital growth as this becomes a critical factor when it is financed by a major loan.

Making a choice between an established dwelling verses a newly built property can also affect your ability to manage two loans. A recently established property should have lower maintenance costs and potentially higher depreciation claims; but it’s also important to be sure that a new building will deliver capital gains. Depreciation can be a great trump card when buying a new property but the downside is that a lot of new strata properties are constructed on pieces of land that won’t rise in value by much in the short term.

Juggling a new mortgage in addition to your home loan also means that there will be two sets of ongoing expenses; and as a landlord you have to be careful not to be caught out short. Often investors don’t plan ahead for the shortfalls and simply assume that they will be able to “makes things work” after purchasing an investment property. Whilst this may not seems like too much of a hassle when considering today’s low interest rate; it’s a far riskier approach if rates climb higher.

Before you dive into your second property, you should consider the full cost of the property. This includes upfront costs like stamp duty as well as ongoing costs like property management fees, insurance, land tax, council rates etc. It’s important that you can comfortably manage all these expenses when the property is vacant not just when it is occupied. It is essential that every investor makes and keeps a contingency plan just in case any shortfalls arises due to vacancies and/or major repairs and maintenance pop up.

To help avoid shortfalls that coincide with long periods of vacancy, it is important that potential investors do their research and opt for a property that has proven low vacancy rates and decent rent returns; as well as making the effort to keep it maintained and looking after the tenant. At times, landlords may be tempted to cut corners when it comes to property maintenance, but by treating your tenants as VIPs, this will help to stamp out long or abrupt vacancy periods.

In order to help ease your juggling woes, setting up the right finance from the get go is a key aspect of managing a home and investment loan. These two loans should be kept separate, even though it might seem like a good idea to use a single loan for both your home and rental property. This is due to the fact that one of the greatest errors investors make is by dipping into an investment loan to fund personal costs.

For example, most basic loans tend to come with a redraw (which allows extra payments to be withdrawn) however using a redraw on an investment loan can have serious tax implications if the funds are used for personal spending. Let’s say you have an investment loan currently worth $450,000. We’ll also assume that over time you’ve made extra loan payments totalling $10,000 to pay for a family holiday; therefore the loan balance will increase to $460,000. The problem with this is that you can only claim a tax deduction for interest relating to a balance of $450,000 because the $10,000 redraw was for personal use. The ability of the tax office to cross-match data these days means that those taxpayers claiming personal costs rather than costs relating to the investment property will most likely get caught out by the ATO.

Therefore as interest on your home loan cannot normally be claimed on tax, if you have some spare cash, the golden rule is to make extra repayments on you home loan rather than the investment loan. This will also help to avoid any nasty shocks from the ATO if you were to redraw on the home loan for personal use as opposed to our abovementioned scenario with an investment loan. Additionally, as interest on an investment loan is tax deductible, there’s no real incentive to pay off the investment loan sooner.

An offset investment loan can be more tax friendly. This is where a savings or transaction account is linked to the loan. Instead of earning separate interest on the linked account (which would be fully taxable) the account balance is “offset” against the debt and reduces the amount on which interest is calculated. This lowers the interest cost and more of each regular repayment goes towards paying off the principal. By opting for an investment loan with an offset account can also provide a pool of funds for rental property expenses without affecting the tax treatment of the loan interest.

Another part of this mortgage juggling act is maintaining a healthy cash flow. This is critical when you’re facing two sets of mortgage repayments. One option is to spread the tax benefits of negative gearing throughout the year rather than waiting for tax time. Negatively geared investors can apply for a PAYG variation wherein the amount of tax withheld from your regular wage or salary is varied in accordance with your expected rental losses. Be careful when applying for this type of variation as it may be tempting to overstate the amount of rental losses, only to find yourself slugged with a massive tax bill come tax time.

Lastly, investors should stay on top of the loan market and be aware of the changes so as to ensure that you are continually paying the most competitive rates on both your home and investment loan. A range of insurances are also available to help protect cash flow. Some landlord insurance policies give the option of taking out protection against rent default or damage to the property by the tenant.

Overall, by establishing a good budget, contingency plan and loan set up, you’re well on your way to crafting the best mortgage juggling act. For more information and or if you’re looking to buy a property, contact us on 02 9299 7044 or visit www.clarencestreetmortgages.com.au.

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