Why Falling Interest Rates Can Be A Trap Investors
Some of my clients and some potential clients have recently began to discover this challenge. The excitement starts as interest rates fall. Our holding costs decrease and we have a higher regular cashflow. Coupled with that when we review how servicing position – that is how much we can borrow from the bank, we find that increased cashflow with the same assets allows us to borrow even more.
And enter the dragon!!!!
Some people then start on a shopping spree thinking that just because they can borrow more – they should do so. For home buyers and investors it’s easy to get caught in the trap of borrowing the maximum amount you can before actually crunching the numbers. It’s an easy snare to be whisked away into the romantic notion of affording something well and truly out of your reach. It’s so tempting when that beautiful home is only $50K more…..and it is so much more visually appealing, a much more enticing aesthetic than the more affordable home you were looking at a few months back………. and if your looking to live in it your emotions are awry with notions of you living there; your visualising your coffee on the sun-drenched verandah and the kids playing in the perfectly manicured gardens! And why not you tell yourself – the bank says yes! Alternatively if it’s an investment property – falling in love with a property is just as easy!
I can see it happening all over Australia – people letting their emotions get involved in the deal and falling into the trap of borrowing more money! And that’s how easy it can happen – just because you’re told you can – you do! And BANG…….. Your in debt for an extra $50K – $100K due to emotion and your stuck in this debt cycle for years and years! This romantic love affair soon ends and reality hits as you have to fork out huge repayments each week!
The secret to buying investments and being a successful investor is having a strategic plan. Know what you are wanting from your investments. Then consult your plan. If you don’t have one – get one. Your plan should detail your goals, financial and emotional. It should include your If you don’t know how to get one – contact me ASAP.
Being a successful property investor requires some amount of personal change and the ability to think differently than you have previously.
Real estate is a sensational tool for wealth creation and financial freedom even passive income if you take out the emotion, crunch your numbers, have a personalised plan and think of it as a business.
An investment consists of the land and the building. The ATO gives property investors a tax deduction for the provision of property to the rental market. As the land goes up in value and appreciates, the building reduces in value, which is a perk for property investors – for as the building depreciates the losses are tax deductible. Therefore you MUST take note that what you might have thought was bad (building depreciation) is actually good (lower taxes).
Good debt is a loan on an investment property. The debt allows you to buy an asset that creates income (rent), gives you tax deductions and increases in value more than its costs.
Bad debt is the hire or purchase of a flat screen television for $10,000. It creates no income, you get no tax deductions and the product rapidly decreases in value. You end up paying $20,000 dollars over five years for something that ends up being worth $500. Bad debt can cripple you as an investor. It drains the financial life out of you on paper as well as sucking actual money out of your pocket.
When you go to apply for a loan on an investment property (good debt), the banks do a special little computation called a serviceability calculation, which basically asks the question: have you got enough spare cash to cover your debts?
Living in your own home has no benefit for cashflow as it is considered bad debt, unlike an investment property that is considered good debt. So here’s an idea: move out of the house that is not in your dream location and go rent somewhere that is. Instantly your bad debt becomes good debt.
However also buying to purely reduce your taxable income – or using negative gearing as a strategy, is something I would also be very wary of, and again needs close scrutiny of your personal situation to crunch the numbers.
My advice DO NOT get caught in the hype of falling interest rates excitement, or go out and lock in your loan or even go out and borrow ridiculous amounts of money because you can – to buy a dream home or better looking investment property. Ensure you have a plan. Maybe use the increased cashflow to consolidate and build a stronger position for when rates do go up.
With interest rates dropping you could be saving yourself $50pw. Now you may be thinking, “Big deal! I can’t go out for dinner with a nice bottle of wine once a week for that!” Well hang on; paying an extra $50pw on an average $300K loan on a 6.25% interest rate over 30 years – takes around $103K off your loan and shaves around 7 years off your loan life! I can show you how to fast track this process and the exact steps to reduce your bad debt and take decades off your mortgage!
DON’T LEVERAGE to the max without understanding your cash-flow position in 12 months to 3 years.