1300 1ADVICE
Book your free
appointment
Ben Kingsley

14/12/2015
Blog post by Ben Kingsley

Putting your money to work – Money Management & Loan Structure

So in this How to Session, we are rolling our sleeves up and we are getting into a little bit more Expert level understanding on putting our money to work. Now in this session, we are putting our money to work and I’m also going to put a bit of flavor in this one and talk about how we can do this without impacting on the household budget. So let’s take a look.

What we’re talking about here is a $450,000 owner occupied property. Now the bank has $90,000 in security and we have a current loan of $90,000 against this property. Now let’s take a bit more detailed look at that. A $90,000 and 6% interest rate equals to we’ve got 8 years to go for that loan to be repaid. So principal and insurance repayments are $1,183. That sounds pretty sensible. Now, we have equity in our family home. So there is two things we need when we are investing remember? We need equity and we need income. So in this particular case, if we look at 80% a loan to value ratio, we’ve got $360,000 minus the $90,000 that we’ve already taken out in borrowings. So we’ve got $270,000 left. So let’s go off and look to buy an investment property. And why do we want to put our money to work? Well, just think about it like this. If we can save a $1,000 and put it in the back every month, it’s going to slowly creep up but when we are actually talking about controlling an asset worth $450,000. From Day 1, we get the return from $450,000. So we’ll get the income and the capital value appreciation. And that’s the power of property. It’s not for everyone but it’s important to understand that’s why we do it. So here we are, $450,000 property. Now, one of the negative thing about buying a property is lots of acquisition cost. So around 5%. Anything over $500,000 assume 6%. It’s going to cost us $22,500 or a total of $472,500 to acquire this investment property.

Right, so we are going to take a new loan. Those of you who have watched our beginners and our intermediate How to Sessions, we’ve talked about cross-securitisation so here we are. We’ve got $360,00 or a loan to value ratio of 80% against this investment property and we are going to release some of those funds from there. So you can see here. I’ve released a $162,000 of a potential $270,000 and I’ve released $50,000 as a buffer. Really important to understand that if you are getting into investing, you got to be sensible. You got to make sure you’ve got some emergency funds. Now technically, we’re not drawing that money down so we are not paying interest on it. But we are just putting it away maybe our offset account or our line of credit facility and we are keeping that to the side. So if something does happen, we can buy time and get ourselves back on our feet. That $50,000 is emergency reserve and we are taking $162,500 out. So, what are we doing? That $112,000 because we need that $112,000 plus $360,000 is going to be our total repayment. So you can see it up here in isolation and you can see me grouping it together down here. Now, that’s the money to buy this property. So we are borrowing effectively a 105% of the value of this investment property. Now we are going to get rent for that property. We assume 4% rent so a total of $1,500 per month that we’re going to get. Now, we’ve got $1,500 and we subtract it from the cost of holding that property and we are running the property at a loss of $863 per month.

Now, we are running a loss at the early stage because make no mistake, we are not in this in a short term speculation. We are going to run this long term and over time, we are going to pay this debt down and rent is going to go up and we are going to start living the positive gearing of this property.

But right now, the property is negative and that means we can get a tax rebate of whatever our tax rate at the time is and in this particular example, I’m just using 30 cents in a dollar. So that would reduce down to $604 per month or $151 per week to hold that property. Now, if you’ve got surplus in your household budget of around that or probably a bit more because we got to understand that there are other holding cost and we also need to understand that if there is depreciation, that’s going to improve cash flow but the holding cost, occupancy rate, maintenance and those type of things are extra cost that we need to consider. So it’s important to understand that you probably want to have around maybe $200 or $250 a week in surplus before you start to think about this kind of exercise. But here’s what I want to talk to you about. About putting your money to work and to be a little bit smarter. This is why this is in the Expert section of our How to and that is how can we change that? How can we make this a little different?

You’d noticed that I’ve just taken those repayment out on our current principal place of residence with 8 years to go and I’ve rejigged this. So through a sensible artistry, what we’d have been able to do is say that $90,000, I’m going to reboot that loan back out to 30 years. That means my principal interest repayments is going to be $540 each month but that gives me a surplus. So instead of paying $1,183, I’m now paying $540 which means I’m able to without touching the household budget, I’m able to release or find that cash flow to control this investment property. So right now, we are potentially in a position, subject to going and speaking to a professional and doing some sensible cash flow modelling, understanding future changes that is going to occur in your household and getting some great advice to be able to do something like this. But that’s where the measure is. In terms of being able to sort of look at your budget and see ways in which you can control that. Now of course, having a loan over a longer period of time means we are going to incur more interest. So the uplift has to be in the asset that we buy to make this worthwhile.

I mean, we do not do this just to pay more interest to the bank. Trust me, they make enough profit don’t they? So in this case, let’s look at how this plays out. The owner occupier has his property here and the value of that property is growing at 7% each year and there is still interest of 6%. So you can see that just after 5 years between 5 and 6, they are going to pay that loan off. Now, they are obviously going to have surplus cash here and what they do with those surplus cash is obviously going to affect their wealth creation in time but in this particular example, I’m going to illustrate the difference between the value of holding one asset as oppose to the value of holding 2 assets. So here, instead of having one, we are controlling a bigger asset base and you can see over 5 years, 10 years, 15 and 20 years, we are going to able to grow substantial asset base. Now, interestingly, I haven’t change the debt. So the debt has remained. Obviously, we are going to be in a position to pay that debt down but I just want to illustrate the same example that even if the debt is maintained, the equity that we are basically building over time which is the combination of these two, not just the investment property. But you can see here, the net result over a 20 year period is the difference between $1.7 million and $3.4 million minus $522,000 which gives us around $1.2 million dollars difference in net worth. And that’s where we see value in what we’re doing. So property is a long term investment. It does require good cash flow management. We cannot stress that enough.

But if you are smart and sophisticated in terms of how you manage money, you can create this. Imagine if you can do another one and another one, and perhaps 3 or 4 over that 20 or 25 year period? That’s going to set you up for a great passive income in retirement and it’s all about making sure you get those model correct. Let’s wrap this up. Putting money to work. That’s what we are talking about here being that sophisticated money manager. It’s about saying what’s the cost of my money, can I re-jig that cost so that I can then release that equity out so I can put it to work and put the cash flow to work. That’s what we’ve done here. We are simply showing it with one property to give you a great understanding of how this work.

Now, if you want to see anymore of our How to Sessions and we’ve got basic, intermediate and expert session, just visit our website at empowerwealth.com.au.

Connect with Empower Wealth:
Get in the know - Subscribe to our Newsletter