Property investors when starting out often desire to build a multiple property portfolio. They have good intentions, then find their momentum slows or worse their plans are derailed when the bank says no!
As a property investor your goal to purchase many properties is controlled a lot by your ability to borrow money to complete your purchase. Many Property Investors dreams end up broken, tossed against the rocks at the mercy of banks. Being told they have run out of equity or savings and now cannot purchase their next property. Although the property investor’s income is fine, they now need to sit out of the market and wait for either the current property value to grow or save up more money.
The above situation often happens because property investors don’t take advantage of banks, their policies and products. One of the biggest and underutilised tools available for Australian property investors is LMI or Lender’s Mortgage Insurance.
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Now the dilemma!
To use or not to use LMI?
- Why pay for insurance that protects the bank?
- It’s a cost!
- Just cross collateralise and avoid the LMI!
- Who do we listen to?
- Without LMI the Banks are more lenient
For close to 30 years we have been helping homeowners and investors, we have seen many property investors trying to build a multiple property portfolio, avoid the LMI and then run out of steam very quickly.
For Property investors, lender’s mortgage insurance is a helpful tool in building a multi property portfolio. Residential property prices are less likely to fluctuate and are a less volatile form of investment, providing the best security to banks. With LMI, some lenders can lend up to 97% of the property value (95% is more common), which means you can buy a property with a lot less savings. Without LMI the banks will lend only to 80% of the property value. You would then need to come up with 20% deposit plus the fees, which is a lot more.
I can hear you saying, “But I have to pay the LMI fee and it only protects the bank”
This is correct, however as a property investor the LMI fee is treated differently to a home owner.
Homeowners pay the fee and it is a direct cost to them, the benefits are they can buy a home or get into the market with a lot less money, especially useful for first home owners getting started.
Property Investors have many added advantages, here are a few:
- Tax deductibility, the LMI is a borrowing cost for investment purposes and can be claimed or depreciated over the first five years.
- LMI can be added to the loan, further reducing funds needed to settle.
- Using LMI preserves your capital for future use on another property.
- After tax cash flow can be increased due to the higher tax write off.
- Using less of your own money can increase your return on your investment.
- Using LMI can minimise the risk against your own home.
- It gives the investor more flexibility to use different lenders for different properties. Lenders policies can change, one lender may be the best today and not tomorrow.
- Using LMI can mean two or three properties could be purchased straight away, taking advantage of market conditions or time in the market.
Let’s say you purchased a property for $400,000.
To avoid the LMI you would need 20% or $80,000 as a deposit, not including fees.
Borrowing 90% would mean a 10% or $40,000 deposit is required.
At a 95% lend, you would only require 5% or $20,000 deposit.
As an example, you have $100,000 of equity or funds available, you could buy just one at 80% or you could purchase more investment properties quicker and use the LMI wisely to your advantage.
The long term benefit of purchasing more good properties for less equity will outweigh the cost of the LMI. One property going up at 5% pa will give you $20,000 of capital growth in a 12 month period, two $400,000 properties growing at 5% pa will give you $40,000, doubling your return over the same time frame.
The financial leverage provided by using LMI helps increase the purchasing power of investors who want to build a better property portfolio. The ability to borrow a higher amount certainly helps first-time investors get started sooner.
Importantly, you also need to keep in mind that the LMI is not just about the financial leverage. The misuse of LMI can create a lot of potential risk.
Putting less of your funds for a deposit will enable you to buy more property, however you will still need to be careful with the property you buy, you want good growth locations and property types. Just because you can buy more or purchase at a higher price doesn’t mean you have too. Do your research and due diligence, check that you will have suffice funds for all fees that need to be covered and room to move if needed in the future. Using LMI wisely can bring great benefits, however if used without respect it can bite you hard.
Managing your cash flow is the critical component in property investment and this is more so when leveraging and using LMI, done safely with the right structures it can multiply your returns on your investment.
The longer you intend to hold the property, the better.
Short term is speculation and this will increase your risk if using LMI unwisely.
Seek professional advice and guidance from an investment property mentor and a switched on mortgage broker with property investment experience. Take it one step at a time.
Purchase your property with the use of LMI but always insure that you still have a financial buffer by setting up available cash for a safety net.
Being in debt and borrowing more might sound scary, but it’s not like your home where you are paying for it all yourself. Property investment allows you to control the property for a lot less, you have the tenant and tax paying for most of it, if not all of it.
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