Why invest in property?

Is there a better feeling than living in your own home? But investing in property is more than that feeling.

It's an asset that can start generating you income from the day you own it. But figuring out the best options for your own personal circumstances is often the hardest part.

Why look at an investment property before buying your own home?

If you're young and not too concerned with buying a house just yet, you still might want to think about the benefits of property investment.

Investing in property while you are young can be a great way to build a solid financial foundation for the future. You can get all the benefits of home ownership, like building equity in a large asset, while enjoying the flexibility of continuing to rent.

It's a common strategy for many first time buyers to choose to invest in a property rather than to live in it because they can afford a property or suburb they would otherwise not be able to. The reason for this is because when you apply for a loan as an investment, lenders will increase your borrowing capacity because they will factor in the income you will generate from rent, on top of your regular income.

Julie and Sam, both aged 26 have no children and earn a combined income of $160,000. They wanted to start building some equity in property but were unsure if they should buy to live in or invest. Their maximum borrowing capacity was around $1.1M, repayments on a loan that size were $6,500 per month. Repayments that high would have left Julie and Sam sacrificing more of their lifestyle than they'd like. So Sam and Julie considered purchasing a property as an investment. Factoring in the extra income they would receive from renting a property they realized they could purchase a unit and build equity while not sacrificing too much of their existing lifestyle.

The trick with investment property is that once you've saved your pennies and secured a home loan, you can get tenants to pay your mortgage off.

This would mean that while paying rent for the accommodation you are living in, you're also building equity in a property as your tenants contribute to your mortgage.

That equity could come in handy in a few years' time if you wish to get a competitive loan for another property purchase.

If I already own my home, why should I consider investing in an additional property?

If you already have an owner-occupied property, the equity that may be present in your family home will give you a leg up above the first-time-buyer investor.

By tapping into the equity in your home you can borrow more than 80% of the value of another property without being subject to LMI (lenders mortgage insurance), because the new loan is secured against your existing equity.

By drawing upon the equity in your existing home, you can buy into your first investment property with a smaller mortgage, and in the eyes of your lender you will have reduced your risk as a borrower.

In saying this, there is a portion of risk that still remains. When you draw upon the equity in your owner occupied home, you leave yourself open to losing both properties if you default on your mortgage.

It is important you seek professional financial advice before using your family home as collateral.

A common belief people have is the notion they don't have the financial capacity to even consider buying another place.

Existing property owners who have paid off at least 20 per cent of their property can easily borrow to purchase another property - without the need for an additional deposit or even a large financial commitment.

This is called accessing the equity in your property.

The Smith's bought a home in a Melbourne suburb in 2005 for $460,000. Over the past 10 years they paid off $160,000 of the principle balance of the loan, leaving them with a loan balance of $300,000. The Smith's decided they want to buy an investment apartment so they had a valuer come by and revalue their existing home. The home they bought in 2005 was now worth $750,000. With a remaining balance of $300,000 the Smith's had $450,000 of equity in their property.

First-time investors often use the equity in a principal place of residence (PPR) as additional security for their investment property purchase as this decreases the size of the deposit required.

Cross-collateralisation is also often used and is the use of two or more properties to secure a single loan - in this case the PPR and the investment property.

Advantages of cross-collateralisation include increased borrowing power, higher loan to value ratio, less paperwork and reduced fees and charges.

Planning and targeted advice can make a real difference in the success of your first real estate investment.

Should you be paying off your home loan with extra repayments whilst property prices are rising?

Take Adam and Jo for example. They have a home valued at $500,000 and a home loan at $350,000 with repayments of $1,870 a month. Adam and Jo though choose to pay $2,400 per month because they want to pay off their mortgage as fast as they can.

Another couple John and Samantha who have exactly the same home and loan value have decided not to pay extra money off their home loan, but rather to buy an investment property (using their home equity) valued at $350,000 with a loan of $375,000. Their accountant advised them to ensure their investment loan was interest only, but to keep their home loan at principal and interest.

Here's the outcome for the 2 couples after 7 years and a rising property market:

Adam and Jo:

  • Home Value $850,000
  • Home Loan $254,500
  • Equity: $595,500

John and Sam:

  • Home Value $850,000
  • Investment Value $600,000
  • Home Loan $308,000
  • Investment Loan $350,000
  • Equity: $792,000

Quite simply, John and Samantha took advantage of a rising market using their cash which they were using to pay down their home loan; placing it towards another property to earn them capital growth. With rent and negative gearing getting them a hefty tax refund, the new investment cost them nothing extra out of their own pocket.

Of course, you need to be careful where you buy and getting the right advice is integral to achieving good capital growth even during a rising market. Be diligent in your search and don't be afraid to look interstate to get a good area if you can't afford to buy where you want to in your own state.

What are the financial benefits of investing in property?

Capital growth

Capital growth is the continued growth in the value of your property over time. This strategy generally requires you to hold onto the asset over a longer period of time.

If you purchased a property in 2010 for $300,000 and it grew in value by 5% each year it would be worth $383,000 in 2015. In that time, you would havemade a $83,000 capital gain minus your expenses and taxes.

Rental and investment yield

Rental yield is the money you earn from your rental income minus the expense you incur owning the property. In popular areas, rental rates can provide property investors with an income stream each month. Investment yield is the yearly amount of rental income you earn divided by the total loan deposit you made.

If you earned $10,000 in rental income and deposited $100,000 on your loan your investment yield would be 10%.

Tax benefits

There are tax advantages for all types of property investors; you can claim expenses you incur owning the property, deductions for depreciation and there's a practice called negative gearing we will explain later.

Lauren owns a one-bedroom investment property in a regional area of Queensland. She collects $1,300 a month in rent and her loan repayments are $1,500 a month and she incurs $300 a month in other costs. Each month she has to cover the $500 shortfall in cash flow from the investment. At the end of the year, Lauren has lost a total of $6,000 from her investment and claims the total on her tax return alongside her $100,000 a year salary. This reduces her taxable income to $94,000.

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