Borrowing to invest in property is a popular and highly effective wealth accumulation strategy if it’s implemented correctly. However, loan structuring can often be an afterthought. The reality is that loan structuring and maximising your borrowing capacity is almost just as important as buying the right property. This blog sets out how to structure your loans to build a property portfolio.
A step-by-step example
The video below takes you through an example of how to structure your loans.
Step one: access equity (deposit loan)
You will need to pay a deposit (usually 10%) when you purchase a property. Therefore, you need to arrange access to these borrowed funds. Even if you have access to cash savings, I still recommend that you establish a new loan.
This blog explains why this is important.
I recommend arranging a loan sufficient to fund 20% of the property’s value plus all costs in addition to a buffer. This loan will be secured by an existing property e.g. your home.
Step two: arrange an 80% loan
You will be able to fund 20% plus all costs from the deposit loan. Therefore, you need to arrange a second investment loan to fund the remaining 80%. This loan will be secured by the investment property only. This loan should be pre-approved before you purchase.
Step three: consolidate loans
When your investment property’s value has risen by 35% to 40% above the purchase price, which could take 5 to 7 years, you should be able to consolidate the deposit loan with the 80% loan so that all the debt is in one loan solely secured by the investment property. In this case, your home is no longer required as security.
This structure avoids cross-securitisation which is important as explained in
this blog.
Additional investment properties
If you plan to invest in multiple properties, you can repeat the steps above. For simplicity, it is acceptable to maintain one deposit loan to fund deposits for multiple properties. If you do so, you must maintain good record keeping. Personally, I maintain a spreadsheet that includes a list of all purchasing costs, as that helps me verify loan amounts and calculates the investment property’s cost base for CGT purposes.
Current considerations
The table below sets out how we generally structure interest rates and repayments in the current environment. Of course, if you are reading this blog after 2021, these recommendations may no longer be appropriate.
Successful investors don’t care about interest rates
Borrowing costs (interest rates and fees) are important, of course. However, maximising your borrowing capacity in a safe and prudent manner is far more important… about 8.5 times more important to be specific!
There are two important benefits resulting from having a higher borrowing capacity. Firstly, you will be able to afford to invest in a higher-quality asset. Higher quality assets generally exhibit higher long-term capital growth rates and lower investment risks. Secondly, it may help you invest in more
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IMPORTANT: This podcast provides general information about finance, taxes, and credit. This means that the content does not consider your specific objectives, financial situation, or needs. It is crucial for you to assess whether the information is suitable for your circumstances before taking any actions based on it. If you find yourself uncertain about the relevance or your specific needs, it is advisable to seek advice from a licensed and trustworthy professional.
