03 Jul How to manage escalating housing debt – John McGrath
In his recent column in Switzer, John McGrath gives some timely advice about staying out of financial trouble.
Debt management is crucial to successful property investment.
Here’s what he had to say:
For most Australians, buying real estate is the biggest financial transaction of their lives and pretty much always involves a seriously high level of debt.
For the record, this is what we call ‘good debt’ because you’re borrowing to purchase an asset that will grow in value over time and contribute to your long-term financial security.
But you’ve still got to manage that debt in the meantime.
CoreLogic RPData has analysed the latest household finance figures from the Reserve Bank, which show the ratio of housing debt to disposable household income at a record high of 140.3%.
It’s been this way for a while – since around 2005, but is now trending a bit higher.
On the flipside, the value of the average Australian’s home and property investments is far higher than the debt on them, with a ratio of housing debt to assets of 28%.
So if the average Australian encountered some kind of crisis, they could sell their assets to pay down their debt pretty easily.
But who would want to do that?
The aim of the game in property is to buy and hold long-term.
To do this, you need to be able to manage your debt.
Tips for managing debt:
1. Interest rate buffer
The most important thing you must do – whether buying for home or investment, is build in a buffer for interest rate rises.
Loan periods are typically 25-30 years and your repayments will be your biggest expense.
You might be able to lock in a rate of 4.5% for five years today, but rates won’t be this low forever.
They’ll be back to 6-8% at some point during your loan period so you need to make sure you can afford your repayments when rates are that high.
2. Financial safety net
You need a safety net for emergency or unforeseen situations.
This is a smaller amount of money that you could perhaps park in redraw to cover extended vacancy periods on investment properties, major repairs to your home or investments and time off work.
Insurance products like income protection will also give you peace of mind that if you get sick and can’t work for an extended period, you will still be able to afford your repayments and other property expenses.
3. Principal and interest on home loans
Most owner-occupiers will have a principal and interest loan on their home, which enables you to build new equity as you pay off the principal.
Principal and interest loans are a good idea because the interest is non tax-deductible and you have to pay it in after-tax dollars.
The quicker you pay back the principal, the less money you’ll pay overall over the life of the loan.
The debt on your home is the one you want to pay off first – before investment property debt.
4. Interest-only on investment loans
Typically, an investor will own their own home with a mortgage and use equity in that property to fund or partly fund an investment purchase. An interest-only loan will mean lower repayments, which is good for cash flow, and your interest payments will be 100% tax deductible.
Some people feel uncomfortable with interest-only loans because they’re not making any headway towards owning their investment asset outright.
But you’re far better off ploughing every spare dollar into your home loan because that debt is non-tax deductible.
Once you own your home outright, then it might make sense to go principal and interest on investment loans – depending on your goals.
5. Variable versus fixed
Fixed rates give you peace of mind but little flexibility.
If you’re considering a fixed loan, make sure you understand the terms and restrictions, such as break fees if you decide to sell the property.
The best part about fixed loans is they give you security in terms of budgeting – the repayments stay the same, no matter what happens in the economy and housing market.
Getting comfortable with housing debt is an important step towards financial security.
Don’t overextend yourself – ever.
But don’t let fear of debt stop you from buying good quality property assets – one to live in and others to rent out.
They might come with debt today, but they will provide security and income for you down the line.
As always, I advise you to consult your accountant or tax advisor before you make any decisions.