Is interest rate really THAT important?
BH: Today I’m chatting with Simon Gillespie who’s the Senior Finance Adviser and an investment savvy finance specialist and we’re going to talk about the question: Is interest rate really that important? I must admit Simon I often get that question from clients where they just say – what’s the best rate you can get me? It’s probably not the best question they should ask is it?
SG: Well it depends on your intention, so lets say for those who want to go and buy a home, and that’s all they want to do – well cost and rate is very important. But let’s say for our clients who typically aren’t just about the home but its about that long term wealth creation, you know, build a portfolio. Rate is a part of the conversation but it’s not the conversation.
BH: It’s a good way to put it. I always think that building a portfolio of property, it’s a game of finance more than it is a game of bricks and mortar. And so I think you really need to understand the principles of finance to really understand how to build a portfolio. So what I thought we’d do today is chat about some of the things that you come across when you’re building portfolios for clients and some of the things they should focus on and perhaps some of the things that they should probably not focus on so much if they want to achieve their end game. So, you’ve got a bit of a framework or a structure when you’re talking to a client that you take them through, what is that?
SG: Yeah, so rate is, as I said, a part of the conversation but typically it starts at the top which is the structure. What do I need? How am I going to get from where I am to where I want to be? So what’s the type of loan structure I need? From there we filter down into – who’s the lender that’s going to give me the preferred structure to complete the portfolio and then what falls in behind is that – How much is it going to cost me? What’s the rate?
BH: Alright, so we have structure, we got lender and then we’ve got rate. So lets talk about those in order. What are some elements, with respect to structure, that borrowers should really be thinking about if they want to build a portfolio?
SG: There’s a lot, so I’ll try and restrict it. But let’s say some of the problems that I see. I mean the majority of my work is really problem solving. People come to me with a problem, how do we solve it, so the structure is part of solving that problem. Some things that I do see is let’s say when people do it themselves. They want to invest in property, I’ve’ got some equity, I want to use it – and maybe they’ve got some money sitting in re-draw. They’ve paid down their home and worked really hard on creating that equity and they go – “I’m going to take that money and I’m going to use that as my deposit cost for my property”. The problem with that is if, you’re not aware is what’s called pollution. You’re polluting your facility between investment and owner occupied debt.
BH: That’s a really critical point isn’t it? Got to keep them separate.
SG: Separate. Clear separation between what’s owner occupied, what’s an investment. because you want to claim the interest that you pay on that investment facility as a deductible expense come tax time. So without that clear separation, how do you determine what’s investment debt – that’s deductible and whats owner occupied as non-deductible? So that comes up every now and again.
BH: It actually has tax ramifications too, because if people are mixing investment and personal and then paying back some of the re-draw, you call it pollution – that’s muddy waters on top of pollution isn’t it? It’s really critical and that what you do by default, is to quarantine the different facilities to make sure that doesn’t happen.
SG: Yep, so you want to have that clear separation. You want to get your equity. You want to get that equity out. Having that clear separation. Offset accounts – we’ve talked about it a lot. Some banks you get a single off-set account, some you can get multiple off-set accounts, which creates additional flexibility with how you manage your money, how you manage your accounts. Flexibility is important that you can get equity when needed. If you have to go over 80% LVR, they will allow you to do so. You don’t want to be restricted by your lender as to what you do and when and how. You want to maintain that loan flexibility so that you can build a portfolio to where it needs to be to create that future life.
BH: I always think about how you don’t want to hit glass ceilings. And by that I mean, just because one bank has a certain policy, that your structure hasn’t allowed you to get additional borrowing. So you don’t really want to be at a ceiling that you can borrow more and keep banging your head on glass. That’s one of the added benefits of getting structure right in the beginning isn’t it? I always think it’s a bit like a game of chess, where you thinking two or three moves in advance. When it comes to building a portfolio, the same applies doesn’t it? You’ve got to be not just thinking about this lending right now but what about the lending that you’re going to do later on in the year or next year.
SG: It’s about the end game. What is the end game? Where do I want to be? So from that, we know who you are, we know where you want to be, we know what your record is, we know what your capacity it is. So it’s not about – how do I get this loan or that loan – it’s how do i get from here to there? The reality is, you have all the bank lined up down a single street, you walk in and out of every door, you will get a different outcome from every single lender, depending on the situations and circumstances. PAYG, self-employed, equity etc, it all changes. So rather than just knocking on every single door, that’s where our value is. Knowing where you are and where you want to be and how to get you there with no detours or minimal detours. You’ll get there quicker.
BH: And it’s about knowing, ok in your circumstances, this is the best option for you. Versus your friend who you’ve spoken to at the barbecue, that suggested they got a loan with x bank but their circumstances are totally different. And like you say, they could be on salary and you could be self employed. So it’s really important to understand and that’s something I don’t think a lot of people think about when they think about interest rate. Different scenarios exist for different lenders and that could undo the benefits of getting the cheaper rate.
SG: I hear it all the time. Client says: this is the package, this is what we need to do, this is how we’re going to do it, this is the cost. Then they go and talk to their mates and come back saying, but my friend is getting for this much or that much. And I go, well that’s relative to their situation. What are they doing? What are they trying to do? Are they just getting a standard home principle and interest and paying it down or are they in a similar situation in creating wealth, looking for equity and flexibility. So it’s very common and it’s an interesting conversation to try and say well yes rate is important but what you need to do and in your situation, this is how it’s going to work.
BH: Have you ever thought in terms of, it’s not about the interest rate you pay right now but it’s the amount of interest that you pay over the life of the loan or the life of the portfolio. Because I think that’s often forgotten. We talk about, each month the reserve bank has an announcement on the first Tuesday of each month on what to do with the interest rate. Without people understanding all the things that you know, in terms of structure, it’s quite easy for them to just default to rate and how it impacts on them as an owner occupied. It’s not as easy for people to understand that there are all these ramifications if you are looking to build a portfolio and you get it wrong.
SG: Yeah well, if you get to a point where the banks says no, well you’re stuck. Doesn’t matter what you intend to do, if the bank says no, well it’s no. You can’t buy that property, you can’t have that in your portfolio, you don’t have that working towards your future
BH: Tell me this, on that point that you just said. What if someone tries to do it themselves and they go for rate only and the bank knocks them bank. It appears on their credit file right?
SH: It does yeah. Unfortunately, I have a client who loved frequent flyer points. And he loved it so much he would apply for every single credit card that offered some kind of free frequent flyer reward, without realizing it. Now he hasn’t purchased a property previously so he’s gone and done this and every single time he did, it hits his credit report. Whether that’s a credit card or a home, every time you apply for credit, it hits your credit report. Unfortunately for him, he’d done it so many times he can’t apply for anymore credit for at least the next 6-12 months. So if you’re going from lender to lender to lender, there will be a point where you’ve inquired too many times that the answer will just be no.
BH: Well there’s a good point for you folks. If you shop around too much, it will have a negative impact on your credit file. So we’ve talked a bit about structure, the next step is about lender. Why should someone consider using an investment savvy finance specialist like yourself versus just sort of going to the bank? Can’t they get a good opportunity if they’ve got a good relationship with their bank that they’ve been banking with for the last 15 years?
SG: Well my default position on banks is they are a product provider. You go to a bank because you want a product. It you want an advise, you come to an adviser. So a banker will do the best they can with the products they have within their institution. Which is limiting. Whereas, for us, we have 40 lenders, so we’ve got more products than we know what to do with. So we just have more choice and flexibility to be able to tailor that structure to an individual’s needs and not the pigeon-holed into – I can only put you into one of these 5 options. That’s the best so there you go. And outside of that, banks do like to cross-securitise. That is a default position that they take if you don’t ask.
Actually I’ve even had it in the past where the client specifically said: I do not want this cross-securitised and I’ve gone back and I’ve told him, you need to go back ask the question because I know this bank default and automatically cross-securitize everything. So they went back and they said, no you’re right. Even though they said don’t, they did. They were pretty upset about that.
BH: So that’s a really critical point there that Simon’s just mentioned. By default, the banks will want to cross-securitise your lending, which as a portfolio builder is not in your best interest. It’s really important that you get someone who is not being paid by the bank specifically for their products, whereas Simon can say: Here’s three options that are available to you but in my opinion, Option B is the best because. And it might mean yo’re across different lenders rather than getting the best option from one particular bank.
So Simon we talked about structure, we then talked about the differences between lenders then we move onto rates. That’s a really good framework for our viewers to think about but is there ever a time that interest rate becomes more important than those others?
SG: There is one point in the future where the rate becomes top of the priority. Once you’ve gone through the accumulation phase. You’ve got your home, you’ve purchased your multiple investment properties, it’s no longer about – How do I continue to build that portfolio because it’s now its just hold and let time take care of the rest. So at that point in time where maybe you’ve got the home paid down, the property’s increased in value, you’ve got lower Loan to Value Ratio (LVR), there’s positive income coming through from those properties, well then if you can go back to the bank, that’s when you start focusing on rate.
Just as a rough guide, it wouldn’t be uncommon for our clients to have at least $1.5 million in debt at some point. At that point in time, if you can reduce your rate by .3 even over that $1.5 million, that’s $4,500 savings a year. $2 million, it’s about $6,000. So once you’ve gone through the process of building a portfolio, its sitting there, its in the bank, it’s no longer about how do I continue to borrow money to create wealth. It’s about how to maintain the wealth I have.
BH: That’s a really good distinguisher. So through the accumulation phase, structure, lender, rate. As soon as you move into the maintenance phase, it’s all about debt retirement. So through that debt retirement it just makes sense hat you focus your attention on rates. I think that’s really good point because top of this video we talked about – is interest rate the most important thing when it comes to lending and if you’re a property investor who’s interested in building a portfolio of properties, I think the message is very clear from Simon, who’s doing this all day, everyday. It’s not the most important thing. It’s important to get your structure right first then your lender and then your rate. I’ve been chatting to Simon Gillespie who’s the senior finance adviser. Investment savvy mortgage specialist who knows how to put structures in place for investors everyday.
So if you’ve got a portfolio yourself or if you are interested in creating a portfolio for yourself and you want to make sure your lending structure is ideal and optimum.Why don’t you go to our website empowerwealth.com.au, leave your details, we’ll put you in touch with Simon or one of our team, so that we can actually access whether your structure is good. We’ll make sure sure you build a portfolio going forward and will serve you well as you get to the maintenance phase.
Simon thanks for your advice, I think some really good tips there and we’ll have you on again soon.