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Avoiding The One Bank Trap
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For Investors, By Investors

Investing in Property in New Zealand

From the outside, Property Investment can be an attractive investment strategy to set you up for retirement, as well as a Kiwi Dream. However, at Kris Pedersen Mortgages, being property investors ourselves we understand that it isn't always easy navigating the property investment landscape, and having the right advice and a strategy is going to be the difference between where you are, and where you'd like to be.

If you're looking to use Property Investment as your retirement plan, then being able to understand your mortgage options is crucial to your success. We work with numerous lenders - both main-bank, and non-bank lenders and can explore all options to help you achieve your goals.

There is a lot of work that goes into property investment, and we want to ensure that when it comes to your finances, you're set-up correctly to make this as simple as possible for you.

Understand Your Mortgage Options

Split Banking

One area we see a lot of investors make a mistake is that they tend to start by purchasing their own personal residence and then go straight back to the same lender to fund their first investment purchase. Often the lenders involved state that they can be 100% financed into this and future investment purchases which is actually achieved by utilizing equity built up in the family home and hooking the loans and securities together.

If something goes wrong this situation is beneficial for the lender as they have complete control however not a position that is good for the borrower as they have very little control.

We recommend adopting a process called split banking where we look to keep the family home with one lender who we won’t look to have any investment properties also secured with.

We then look to get a revolving credit facility (a large overdraft but at mortgage rates so you only pay for what you use) set up against the family home from which you take deposit funds and also renovation funds if part of your strategy is to tidy the properties up.

We then get a preapproval in place with a secondary lender for 80% of a proposed purchase price so that when a potential purchase arrives you have the funding in place to move quickly.

With your investment purchases you should aim to purchase properties either at a discount or where value can be added. Even if you don’t achieve this you should over time get some capital gains and we then look to go back to the secondary lender and top up to 80% of the increased value and then use these funds to reduce the balance on the revolving credit facility.

To find out more if split banking is for you please either contact us for a Finance Strategy Meeting HERE or download our One Bank Trap eBook above.

Understanding Serviceability

While it is relatively simple to understand the equity / deposit requirements which lenders have in place we find many property investors hit brick walls eventually as they don’t understand the way that most lenders assess servicing.

As an investor, you want to start by assessing what it is that you want to achieve from your investments and use this to set purchasing rules. As an example, this may be trying to purchase the properties at a certain discount to what you believe the property to be worth and also a certain return.

We recommend that investors set their return goals based on net yield (annual rent minus rates and insurance costs divided by purchase price) rather than gross yield (just the annual rent divided by the purchase price).

Thus when looking at a prospective property purchase as an investor you will look at the numbers as a basic profit and loss however note that the way the lenders look at the numbers is quite different.

Key points to note are:

  • Lenders only take 70-80% of rental income into consideration.
  • While lenders may allow you to have the mortgage on an interest only basis when calculating servicing they assess all debt on a principal and interest basis.
  • Generally rather than assessing servicing off the actual interest rates that you are paying currently, lenders use qualifying or assessment rates which can be considerably higher than the actual rates being paid.
  • If you are self employed or have hit a certain sized property portfolio at some lenders you may be assessed at a business banking division. What can happen is that unlike retail banking where the lenders generally amortise the debt over 30 years from a servicing point of view some business bankers will work off residual loan terms meaning that the payments are calculated on a principal and interest basis off the remaining loan term and if an interest only basis is included the remaining term once this has expired.

What tends to happen is that even if you can source positive cashflow properties often with the way lenders assess numbers they look negative to the lender. This means that most investors only have so much servicing before they hit a brick wall and can’t borrow any more unless they can increase income or decrease debt levels to a stage where servicing works again.

For more in-depth information around this - check out our blog here.

Principal & Interest Vs Interest-Only

To start it is worth understanding why many investors look to utilise interest only mortgages.

Firstly, it is recommended from a tax point of view as if you still have personal debt (i.e a mortgage on your personal residence) it makes sense to consider paying off personal debt prior to paying off investment debt as the personal debt is not normally tax deductible.

Secondly, you will hear often from speakers at property investment events that it is better to focus on going interest-only and using the increased cash flow to purchase more properties than to focus on reducing principal. The argument in favour of this strategy is that you can gain more wealth from capital growth than you can from paying off principal. While this argument has some validity especially over the last couple of property cycles there are other considerations such as:

  • Often investor’s who are utilizing interest only loans so they can grow a larger portfolio, end up having to sell some property off as interest rates rise and they don’t have much cashflow flexibility. Note that if you pay principal and interest then you have the flexibility to go interest only thus freeing up cashflow.
  • Note that often having a counter-cyclical investment strategy is the best way to build an investment portfolio. What this means is that often when the economy is in a recessionary stage it is easier to purchase properties at a larger discount. Note however that this also tends to be the period where it is hardest to obtain funding as banks and other lenders tend to tighten their criteria considerably through this period. Investors who have a history of repaying principal rather than just staying on interest only have a higher chance of getting funding in the tough times.

While everyone is at different stages of their lives in regards to both age and investing experience, what we often recommend is to look to structure the mortgages in such a way that:

  • You adopt a split banking strategy (see our One Bank Trap eBook for more info) and look to put the investment properties on interest only.
  • We then recommend calculating what the mortgage payments would be as if all mortgage debt was on principal and interest, you can then deduct what the investment mortgage interest only payments are from this figure and then direct whatever is left over towards the principal on your own residence. If you can be disciplined we recommend directing the surplus into a revolving credit facility which be used for future deposits and renovation funds for future purchases or otherwise can be built up as a safety buffer. This strategy has the benefits of being better from an asset protection point of view as you are building more equity in your own home which shouldn’t be cross secured into the investments and also allows for a buffer as you can always reduce the payments to the revolving credit facility if cashflow gets tight.

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