A home loan in this context is your personal, non-deductible home loan, secured by your home. The investment loan is the loan that was used to buy your investment property. The vast majority of property investors use the same lender for their home loan and their investment loan.

Under the provisions of the “all monies mortgage clause” this finance structure exposes the family home to all the debt (both deductible and non-deductible), in doing so place their home at greater risk.

Banks are authorised in certain circumstances to not only sell the investment property but all securities (including the family home) as a consequence of invoking its right to withdraw all funding. What is not usually understood by borrowers is that banks can withdraw all funding not only in the event of the more usual ’standard’ default (missed payments) but because of a ‘technical’ default brought about by what the banks call a “material adverse change in circumstances” triggering a ‘general’ default.

This circumstance usually leaves a property investor stranded without finance and without the ability to secure finance in time creating a real risk for the entire portfolio.

Protect your family home

Correct structuring can add a layer of protection to the family home (a ‘firewall’) giving the investor options to not only save their home but their portfolio as well.

For more information, check out this post about the banks secret weapon. You don’t want to end up like this!

This is a complex topic, if you would like to discuss it further or you are concerned you are exposed to this risk, don’t hesitate to contact our office.

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The Cost of Getting it Wrong

Purchase the wrong property and it could cost you tens of thousands of dollars to replace it with the right property. Poorly structured finance blunts the performance of even the best investment property; slashing your tax refunds, crippling your cashflow, eroding your returns and exposing your home to unnecessary risk.

“Intrinsic Value” is the key

Professional property investors know the right property has one key quality, “intrinsic value”. Intrinsic value is found in quality properties located within a short commutable distance from “highly paid” work. Highly paid work is located in the CBD, Docklands, South Bank and St Kilda Road. A short commutable distance includes the inner suburban areas like Armadale, Toorak, Malvern, St Kilda, Elwood, South Yarra and Hawthorn.

Where to Look

Many investors look past these blue chip suburbs believing that they can’t afford to buy there because they are focused on houses believing them to be a better investment. In fact over the past 12 months, quality boutique flats soared by 17.9% while houses rose slightly less at 17.8%.

Turning Negative into Positive

Other investors look past inner suburban property because the lower yield produces negative cashflow which they make up from ‘after tax’ dollars. However, finance can be structured to neutralise your cashflow and in doing so increase your tax deductions leading to faster home loan elimination and enhanced returns.

Growing your rent

It’s also important to remember that while the initial yield in outlying suburbs might be higher, inner suburban tenants typically have greater capacity for rental increases created by lower vacancies.

The Professional Investor’s Choice

The inner suburbs are the professional property investors’ choice because its yields can surpass their outlying counterparts within a few years and command faster capital growth for the best performance of any market segment.

Asset Protection

Now you have the right property, neutralised your cashflow and optimised your tax position, it’s vital to protect your most important asset, your home.

The most common mistake investors make is using the same bank for your home and investment properties. Should your bank ever consider you have encountered an ‘adverse change in circumstances’ it can withdraw all finance and probably foreclosure. Isolating your investment debt adds greater protection for your home.

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The Warren Buffet Philosophy

The world’s most successful investor, Billionaire Warren Buffet says, “Investing is easy, it just isn’t simple”.

The key to success is getting quality advice from competent, experienced industry professionals. Financial Architect and founder of Investors Edge Finance, Andrew Gardner provides finance structuring, property investment mentoring, education and support, you can contact Andrew on 1300 88 55 96.
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1. Failure to plan:
   1. Purpose/Reason/Objective
   2. Strategy
   3. Resources
2. Wrong property:
   1. Poor location/locality
   2. Splinter investment
   3. Tenant and/or rent-ability issues
3. Poor Structure:
   1. Ownership which results in:
      1. Higher tax liabilities
      2. Asset being put at higher risk
      3. Earlier and higher land tax liabilities
   2. Finance which causes:
      1. Home to be put at excessive risk
      2. Cashflow problems which affects lifestyle
      3. Higher tax liabilities
      4. Stunted returns
4. Excessive risk though:
   1. Excessively high LVR’s
   2. Portfolio imbalance
   3. Lack of awareness of matters such as the All Monies Mortgage clause
   4. Absence of buffers
5. Incorrect finance product:
   1. LOC, IO or P & I affects tax & interest liabilities, cashflow and savings capacity
   2. Offset or high yield a/c which affects tax & interest liabilities and returns
6. Absence of Panel of Experts acting in synergy
7. Lack of awareness:
   1. Using “after-tax” income to subsidise negatively geared properties
   2. Not using ‘natural love & affection’ rules to convert tax liabilities in tax concessions as the rich do
8. Unproductive money flow practices that inadvertently:
   1. Increases your personal home loan
   2. Mixes deductible and non deductible debt clouding deductibility
   3. Creates a growing deductible expense and failing to claim the deduction
   4. Complicates tax recording and reports resulting in lower tax refunds
   5. Diminishes savings capacity & creates the need to repeatedly re-create N/D debt
9. Failing to keep pace with market values resulting in time being wasted on property classes beyond the budget or target range ultimately costing you substantial capital.
10. Getting the balance wrong:
    1. Overleveraged putting the whole portfolio at risk
    2. Underleveraged and not optimising wealth creation

Maximise your returns, call Investors Edge Finance on 03 9509 8911 for a free review

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Let’s see why their finance wasn’t structured correctly…

.1. A lender will always optimise its position, by obtaining and retaining all available properties to secure the loan. The lender is in a powerful position, while Gordon and Sally are in a weak position.

.2. A bank cannot achieve the best possible position for the borrower, because it requires a second lender to counter the AMMC.

.3. Bank Managers don’t understand the AMMC and the danger it exposes the investor to.

.4. A mortgage broker typically won’t structure the finance to give you the safest position because it is a lot more work for the broker, (not you), to deal with two banks and like most bank managers, most mortgage brokers do not understand the AMMC and the risk it poses to you.

.How do you know if you are at risk?

For some, you will have experienced an uneasy twitch as you read through the scenario. For others, you will simply know you are at risk. A simple question to ask yourself:

.Are any of your investment loans with the same lender as your home loan? If so, you could face the same risks Gordon and Sally encountered

.What course of action should you take?

.a) Make arrangements to review your finance structure with a financier specialising in structuring investment finance for property investors.

.b) Go to www.investorsedgefinance.com.au and complete the “Self Audit” questionnaire and study the three reports which will be emailed to you.

.c) Contact us at Investors Edge Finance and a Financial Architect will conduct a wide ranging review of all aspects of your property investing structures, strategies, portfolio, goals and objectives. There is no charge for this consultation.

.Call Helen on 03 9509 8911 to arrange an appointment.

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This whole tragic scenario could have been avoided if only Gordon and Sally had sat down with a financier who was skilled in correctly structuring finance for property investors.

They had made many financing errors, but it was three key mistakes that lead to this disaster:

1. They gave the bank financing their investments access to their home as joint security – albeit, they had no idea they had done so.

2. They had not allowed for a safety net for this instance, to cover an interruption of income.

3. Their exposure to a single lender was way too high leading to fast action by their bank to recover the debt. An “A” class client can very quickly plummet to “D” class.

A skilled “Financial Architect” would have structured his finance to ensure maximum asset protection, particularly for the family home.

Structuring for Protection

.A Financial Architect would have structured Gordon and Sally’s finance to achieve four key objectives:

1. Provide maximum protection for the family home and key assets
2. Protect and maximise cashflow to prevent a repayment default
3. Preserve and protect tax benefits for the future
4. Maximise returns leading to passive income

.Now let’s have a look at how a Financial Architect would have structured Gordon and Sally’s finance.

Protecting the Home

First and foremost, the home would have been protected. This is achieved by isolating it from the banks providing the investment loans, virtually negating the dreaded All Monies Mortgage provisions.

This is done by using a separate lender. The Financial Architect then arranges a “cash transfer” to fund the “hurt money” and costs. This would have reduced the home’s exposure to debt by about 76% or $840,000.

Under a “cash transfer” the home would be exposed to just $598,000 instead of $1.438M.

Guarding against Default

Secondly, Gordon and Sally would have been provided with a safety net to negate the effect of the rental default which caused them to default on their loans, putting their home in jeopardy. If the rent doesn’t come in or there is some other interruption to your income (or you over-spend on your holidays), you can ride it out until things return to normal. We recommend your buffer covers you at least 6 months.

Optimising your Returns

Thirdly, there’s only one reason to invest in property… to make money. Everything you do should revolve around optimising your returns because while you are making money you won’t go broke. “Washing” all your income through your non-deductible home loan can eliminate your home loan very quickly, but it must be structured correctly with the right loan products, money flow and purpose to meet strict tax office rules and court judgements.

Get advice for your situation and circumstances before commencing this strategy.

.On the next post, we talk about why Gordon and Sally’s finance wasn’t structured correctly and how do you know if you are at risk…..

>>

Banks won’t lend 106% of the purchase price against a property without a much higher interest rate
and a huge mortgage insurance fee (which, by the way, only covers the lender… not you - you pay
the premium for their peace of mind!)

As you can see in the diagram below, the bank has actually stripped a whopping $273,000 from
Gordon’s home to secure the loans used to fund the purchases of their investment properties.
Unbeknown to Gordon and Sally, the loans on their investment properties are actually limited to
80% of the value of each property, (80% LVR), a comfortable $1.25 security for every $1 borrowed.

Click here for larger image

To meet Gordon’s demand for stand-alone loans, the bank simply split the loans into deductible and
non-deductible sub accounts.

Their bank stripped $273,000 from the equity Gordon had in his home to cover his 20% ‘hurt money’
he and Sally were (unwittingly) required to contribute, plus purchase costs. They were totally misled
into believing the bank was actually lending 106% against the investment properties.
But it gets worse for Gordon and Sally, much worse.

Under the AMMC, the family home’s ‘exposure to debt’ (that is the debt their home is liable for),
rocketed from $325,000 to a massive $1.438M, nearly 60% higher than the value of his home.

Gordon had no awareness of what the bank had done, and neither do most investors who borrow
money for investments with the same lender as they have for their home.

Suddenly their home is at the mercy of the bank, and they had no idea as the bank manager had
never explained the effect AMMC could have on their own home. Little wonder, a recent survey of
bank managers found that less than 25% of them understood the full implications of the AMMC for
the borrower; many more didn’t even know it existed! How frightening is that?

So, what triggered Gordon and Sally’s catastrophe?

Life had been pretty good for Gordon and Sally, so they decided he would take his long service leave
so they could travel for three months.

Gordon arranged direct debits from their savings account to cover the repayment shortfall after
rent.

It was while Gordon and Sally were overseas that disaster struck. One of their tenants lost his job
and missed a rental payment creating a shortfall in the repayment of $1,170. The bank automatically
issued a default notice demanding immediate payment.

Unaware of the events that were unfolding at home, Gordon and Sally were trekking towards “Base
Camp” in the Himalayas.

Six weeks later they arrived home, exhausted, but exhilarated from their epic journey. The next day
they started to wade through the mountain of mail that had accumulated over the two months
they’d been away.

Upon tearing open the first of a number of letters from Gordon’s bank, his blood ran cold as he
scanned the headline “Notice of Default”. He scrambled to rip open a second letter from his bank as
beads of sweat appeared on his forehead. This time the headline in red screamed “Letter of
Demand – immediate payment required.”

By now their loan was two months in default and the third repayment was due in just 5 days.
Terror set in as Gordon scrambled to find the statement for their savings account. He found it was
overdrawn by $2,751.28. He then fumbled to find their credit card statement; it was just shy of its
limit.

Including default interest, they were now nearly $4,500 behind in payments. Their savings account
was overdrawn and their credit card was nearly ‘maxed out’. They needed over $7,000
immediately. Where were they going to find that sort of money?

Their loans were now in default. If all requirements of the order were not met within 28 days, the
provisions of the All Monies Mortgage Clause provided that ALL loans would be ‘deemed’ to be in
default and would be called up or action taken to sell any or all of the securities (properties),
including their home, to recover any outstanding loans. Remember, the bank is exposed to a single
client for in excess of $1.4M, so alarm bells were ringing… and loudly.

Gordon and Sally’s predicament was now dire. It proved impossible to liquidate these investment
properties within 28 days and equally impossible to secure new finance while in default.

One tenant losing his job had cost Gordon and Sally their $1.9M portfolio, including the family
home, in just a few short months.

The worst was to come… their relationship was at breaking point as they faced their financial ruin.

Find out on our next post what Gordon and Sally’s grave mistakes were….

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You see, their bank, like all lenders, has an insidious ’secret weapon’ embedded in their legal documents, it’s called the “All Monies Mortgage Clause” (AMMC) and it puts them in a commanding position.

So how did Gordon and Sally get themselves into this position?

Years ago, Gordon got a loan from his local bank manager to buy his own home.  About five years ago, after marrying Sally, they decided to buy some investment properties. So, like most property investors, they went back to their bank manager who happily arranged a loan for “106% of the purchase price” for each of the properties, to cover costs and deposits.

“Fantastic”, they thought, “Just like we heard at all those seminars - build a property empire using none of your own money!”

After hearing about the dangers of cross collateralisation from a mate, Gordon insisted on each loan being “stand-alone” and his bank manager happily obliged.

What Gordon didn’t know was that cross collateralisation was to be the least of his worries. It was the AMMC that was to be his downfall.   His unawareness sowed the seed for today’s catastrophe.

Let’s look at how his bank manager explained the setup of his loans

Click here for larger image

You might be thinking that this all looks fine - so where is the problem?

The AMMC threat is subtle and poses no immediate threat; the menace can lay dormant for years, but it does give the bank the means to foreclose almost at will.

Real finance structuring tactics

The way in which their bank structured their loans is actually quite different from the structure illustrated in the first diagram above.

In reality, the bank, which already held the title to Gordon’s home, had simply thrown a net around his home and their investment properties to ‘jointly and severally’ secure the total debt.  That’s right: the bank now has the right under the AMMC to foreclose on any or all of the properties to repay all loans.

The bank has actually ’stripped’ equity from their family home and applied it to the purchase of their investment properties in what is known as an ‘equity transfer’.

Equity transfers are standard banking practice and have enabled mum and dad investors across the country to build a property portfolio, but it has also exposed them to unnecessary dangers.

More about that and how to avoid the traps later…

]]> http://www.investorsedgefinance.com.au/blog/2010/05/the-banks-secret-weapon/feed/ http://www.investorsedgefinance.com.au/blog/2010/05/ten-tax-tips/ http://www.investorsedgefinance.com.au/blog/2010/05/ten-tax-tips/#comments Thu, 13 May 2010 07:04:22 +0000 admin http://www.investorsedgefinance.com.au/blog/?p=101 TIP 1: A deduction rarely claimed
Amazingly the most frequently overlooked tax deduction is interest!  Many advisors tell their clients to pay their rent directly into their home loan to eliminate it more quickly.

However, the required loan structures and practices are rarely established causing the home loan to actually increase as deductible debt is unwittingly mixed with the home loan. Because it is rarely picked up the interest is not claimed leaving the investor with a smaller tax refund and a bigger home loan.

TIP 2: Repair or improvement?
There is a fundamental difference between a repair and an improvement–the former is tax-deductible, but the latter is considered capital and therefore not tax-deductible.

To determine if something is a repair or an improvement, consider: did the work done restore something to its original condition or did it improve it to a condition beyond its original state?

TIP 3: Building allowance
You are generally allowed to claim an annual building allowance of 2.5% or 4% on the construction expenditure incurred on structural improvements attached to land. However, construction expenditure is not synonymous with the amount one pays to acquire the property.

TIP 4: Interest expense
Most people assume that any loan drawn down that is related to their rental property is immediately tax-deductible. While this is generally true, the deductibility of interest is contingent on a strict tracing of loan funds to ascertain the purpose for which the funds are drawn.

TIP 5: Borrowing costs
These are cost associated with the access of loan funds that are used to purchase a property. If the amount incurred is less than $100, it may be claimed as an immediate tax deduction. If the amount exceeds $100, the amount will need to be claimed progressively over the life of the loan or five years, whichever is shorter.

TIP 6: Legal fees
Legal fees related to the purchase of sale of a property are included in its cost base and are not tax-deductible. However, legal costs incurred to deal with the day-to-day operations of the property, eg, drawing up a lease, are tax-deductible.

TIP 7: Body corporate fees
Many property investors seem to think that body corporate fees are categorically tax-deductible. While this is generally true for regular body corporate fees, special levies and sinking funds that are used to fund capital improvements on the property are not tax-deductible.

TIP 8: Travelling expenses to inspect property
If your primary intention to travel to a particular location is to inspect your property but you also intend to use the opportunity to go on a holiday, there will be multiple purposes behind the trip. This means that the associated travelling expenses will need to be reasonably apportioned.

TIP 9: Available for rent?
An expense is only tax-deductible to the extent that the property is used for an income-producing purpose. Therefore if a property is not available for rent for part of the year, the expenses incurred on the property for that year will need to be apportioned.

TIP 10: GST
Residential property leasing does not attract GST, but the leasing of commercial properties does. Generally, if you own commercial properties and the combined projected annual gross rent of these properties will exceed $50,000, you are required to be registered for GST. This will also mean that you are automatically liable for GST on 1/11th of the gross rent, which must be paid to the taxation office.

If you need help with your search or property investment advice give Investors Edge Finance a call on 9509 8911 or email us at info@investorsedgefinance.com.au.

Good question Dave.

Okay, your budget it very limited, so limited that it doesn’t make sense for you to try and get into the inner suburbs because you would end up with a low quality property, probably a tiny 1 bedder.

It would be much better to move further out and buy the right property. One client just bought a great town house for $360K and a strong yield in Frankston South, (this is the good part of Frankston), but you must only look for a townhouse, not a flat.

You can also find excellent properties in Box Hill, Nunawading, Mitcham within a km or so of train station, all good locations, here you need to be looking at 2 bedroom villas rather than townhouses but not a flat unless it’s got some X factor.

What about Other Suburbs?

You will only find 1 bedroom flats in Carnegie, Ormond, Murrumbeena area within your budget, but make sure it’s a spacious 1 bedder, if you feel claustrophobic, don’t buy it.

The property age specification is also very different in the mid outer suburbs from the inner suburbs. If you buy  in Box Hill, Nunawading, Mitcham or Frankston look for around the 10 year old market, you still get good depreciation and good value.

You see the further out you go the more acceptable/desirable newer properties become until you get to the fringe, Pakenham, Cranbourne, Mernda, Melton etc where it must be new but then they lose their appeal as faster than a used car because people go there to buy brand new. Depreciation takes on a whole new meaning!!

So, set up alerts for Box Hill/Nunawading/ Mitcham for a 2 bedroom villa/unit and Ormond/Carnegie/Murrumbeena area for a spacious one bedder and then Frankston for good sized, attractive 2 bedroom Townhouse.

Want to Know More?

If you need help with your search or property investment advice give Investors Edge Finance a call on 9509 8911 or email us at info@investorsedgefinance.com.au.

It was the winter of 1998, I remember it like it was yesterday, I’d just added another two terrific properties to my investment portfolio. My mate “Billy”, not his real name, was aghast, he said he just wouldn’t be able sleep at night with such a debt.

A Lifetime’s Work Wasted

Fast forward 12 years and despite earning a six figure income for a decade “Billy” is a financial bind. He called me for a coffee.  It was sad to see him so despondent. Aged 60 and divorced he is now living in a rented flat with the last remnants of his wealth, an 8 year old sports car and $140,000 cash to which he’s desperately clinging.

“Billy” mentioned he was selling his car and leasing a brand new $52,000 sports car. Now I was aghast!

The Final Nail

Now earning just a fraction of his former income, “Billy” was about to commit to a $1000 per month on top of $1300 pm rent, a lifelong obsession with cars was continuing.

Instantly, I knew that if he went down this path, he would be locked into the rent trap forever. Desperately I searched for the words save him from himself.

“Billy” I started, “if you buy this car you will be committed to $2300 pm!”

“No problem” he interjected, “I can easily afford the repayments”.

An Epiphany

“Well, if you can easily afford it, why don’t you buy yourself a home or an investment property?” I pleaded. “In 7 years it could be worth nearly double rather than buy a car that will lose 75% of its value in that time”.

I could see in his eyes that he was having an epiphany. “What, do you mean I can afford to buy myself a house?” he stuttered, “What would this mean for me”.

The Strategy

I explained that if he bought a house for say $400,000, he could borrow $320,000, take the shortfall from his savings and put the balance into an offset account and be nearly $800 per month better off than staying in the unit and buying a flash new car.

He hesitated for a moment as the words sunk in, “but, what about my car?” he said feebly.

I said, “You’re 60, you don’t need another brand new sports cars, put the money into a 2nd hand Camry.”

“I don’t know if I could afford the repayments, what if my income dropped” he finally said fearfully.

Securing His Future

“Your rent now is $1300 pm, let’s say it increases no more than 5% pa, within 7 years you’d be paying over $1800 pm and you own nothing.” After some quick calculations I added, “On your present income you could easily have repayments on a property down to around $1400 pm by then.”

The Realisation

I explained how his $52,000 car would only be worth maybe $15,000 while his property could easily be worth $650,000, a gain of around $250,000.

Finally, after 12 years, I could see his thinking was starting to shift as he the realised that this may very well be his last chance to finally get into property investment. If he didn’t act quickly and decivisely the conseqences really could be frightening.

“Billy” called me a few days later, he was the most excited I’d seen him in years, he was diligently searching for his first investment property, he’d found a 2nd hand Mitsubishi 380 and, albeit reluctantly, was advertising his beloved sports car.

“Billy” is well on the way to a more comfortable and secure retirement.

Free Consultation
If you or one of your friends aren’t sure what you should be doing, because everyone’s circumstances are different, don’t hesitate to call me on 03 9509 8911, we just might be able to save you from making a mistake and put you on the right path.

Andrew Gardner
Financial Architect
03 9509 8911