Is now the time to refinance and invest?

As we all know over the past few years there has been a significant increase in house prices and especially in Melbourne and Sydney. It is clear that both Sydney and Melbourne property markets have begun to slow down over the past few months but may still see positive growth returns in 2016.

Based on the long term history, it is usual that property markets after a strong period of growth will usually go in to a period of stagnation to allow incomes to rise and debt repayments catch up to the new level of affordability. 

For all homeowners in Sydney and Melbourne, their homes are now like to be worth considerably more than they were in 2011. This recent boom may have added 60%+ on to their house value. 

For example, a house that was worth $800k in 2011, could potentially be worth $1,300,000 in 2016.

But an increase in prices however is really just paper wealth to most families. It is in fact useless unless they decide to sell and downsize in the future. It really is pointless wealth that the next generation will benefit from but does feel nice to have knowing they could always sell.

With this increase in home value however it does create an opportunity. It increases the amount of equity available in the home and by doing so creates the ability to invest further in other assets. 

But why would you want to invest in more assets?

Sadly, most families nowadays will need to build wealth above what they have in superannuation and in their home. With the high debt levels young families need to take out to purchase a family home and the costs to bring children up, it makes it difficult for families to save. Superannuation unfortunately is almost commoditised completely and the lower contribution limits make it difficult to pick up the pace in your 50s for your life in your 70s and 80s.

It is hard to invest because usually the focus is paying down the home loan, having a nice lifestyle and educating the children. It’s very hard to build other investments and the amount going in to Superannuation will usually not be enough. The only way to invest more is to borrow more and the only way to borrow is using the equity in your home. 

For this strategy to work you need time and the earlier you start the better. A timeframe of at least 20 years is ideal and therefore it is most suited to people in their early to mid 40s. Obviously earlier would be even better. 

To give you some numbers behind a strategy here is an example below.

If we look at the house above it is now worth $1,300,000. The loan attached may have been $600,000 on an $800, 000 purchase initially. With the lower interest rates this may have been paid down to $500,000 now. 

Generally speaking banks will be happy to lend up to 80% on the value of the home. So in this case 80% on $1,300,00 is $1,040,000. If the current debt is $500,000, the borrower could release $540,000 as long as their borrowing capacity (their incomes) could support borrowing this amount.

 If we assume they could, the $540,000 would be released and the money would sit in an offset account against the loan and no interest would be paid unless it was invested.

So at this point, the money has been released but it not costing the client anything to have it available. 

This however creates a dilemma - what should they invest in? 

Option 1: Investment Property.

 The good thing about property is the power of leverage. To purchase another property they would only have to have enough equity to cover the 20% deposit and 5% for costs. So 25%.

For example they may look to purchase a classic period home in the inner suburbs of Brisbane, a spacious 2 bedroom unit in a small block of units in eastern suburbs of Sydney or a 2 bedroom cottage with room to improve in inner North of Melbourne. All of those may cost up to $1,000,000.

If we agreed that you need 25%, this would require using $250,000 of this equity available.

What they are however getting by using $250,000 of equity is the ability to buy and hold an asset worth $1,000,000. 4 times what they had available and now have an additional $1,000,000 asset growing for them long term. 

It’s important to note that this is a very simple snapshot and there are many complexities on how this would work. There are also many risks to property investment and many negatives to investing in it as an asset class. 

If however this equity is likely to be available long term and a solid property can be purchased, it may be a good time to consider it with low interests rates.

Option 2: Shares.

 The other option would be to begin to build a share portfolio across both Australia and overseas. It is very easy and simple to do this nowadays with the power of low cost funds. A simple approach here will work best and a timeframe of at least 15-20 years is preferable to ensure the risks of short term volatility being almost removed.

For example, they could use part or all of the $290,000 remaining and decide that they may want to drip feed in $10,000 a month for the next 2 years. This is called dollar cost averaging and is a good strategy to consider when investing in shares. 

The power of shares is that you can do it in small parcels and do not need to buy a $1,000,000 property in this example. They may also decide to sell small parcels in the future when the property is really sell all or nothing. 

There are many benefits to both and there are also plenty of negatives. You do need advice here and a clear understanding on what best suits you. 

Option 3: A mixture of both.

 While I am a lover of top property, I also am avidly against the poor properties out there. I am also a lover of investing in world stock markets, but like property I like to remove as much risk as possible and diversify as much as possible. Recently stock markets around the world have dropped from their highs and are now cheaper than where they were just a few months ago. This drop is a good thing for potential investors.

Simply however, a mixture of both is a great idea and the key is getting the right balance.

 You may be thinking – “how do I afford all this new debt?”

 This is very important to understand but to make it easier you would likely receive a rental income from the property and dividend income from the shares to help pay. With interest rates expected to stay close to all time lows for at least the next 5 years, the shortfall should not be a ridiculous amount and the loss should be tax deductible. Overtime both the rental income and dividends should rise. It is important to note that there are risks with rental income, interest rates rising, no dividends from shares and many other things. A cannot stress enough the importance of understanding the cash flow cost and having a big buffer just in case freely available. This is one of the biggest failures in wealth creation I have seen. 

So where to from here?

 The first thing to do is to assess your current property – the equity you have available and your borrowing capacity - a good mortgage broker can help you here. I also advise you to speak to a financial coach to understand your overall long term strategy and what is going to best suit you. Please remember, that everyone’s situation is undoubtedly unique and what your friends, family or the guy at the pub is doing may not be the best thing for you. 

I would love to hear your thoughts and any feedback. As always, I’m also happy to hear from anyone who I may be able to help and if you like a complimentary discussion my phone number is 0412226009 or email chris@canopyprivate.com.au

 

To be clear this is not advice and general in nature. This articles was used to example how debt and investing can work. If you would like personal financial advice, you will need to speak to me and receive tailored advice to your circumstances via a statement of advice.