How buying an investment property can save you money and provide an income.
It might seem challenging enough to buy one investment property, so why would you buy two? Well, while it might seem counter-intuitive to increase your borrowing, buying an investment property can help you pay off your mortgage sooner. Of course, it will often depend on your income and how your loans are structured, but an investment property offers benefits that help you pay off your loans sooner.
The ideal scenario for an investment property is that it is what we call “positively geared’. This means that you receive more rental income than you need to pay off the mortgage and other costs such as property management. However, it’s unusual to find a positively geared property. Most investment property costs aren’t covered by rental income. To make up the difference, you need to top up that income from your savings. And this is where the tax benefits kick in.
The Australian Tax Office (ATO) works favourably for people who put their own money into an investment property to top up the rental income they receive from tenants. You can deduct any losses from a rental property (such as topping up rent payments to meet mortgage obligations) from your salary income, which results in a lower taxable income. In paying less tax, you have more income to pay more off your home loans. Of course, it’s important to seek independent taxation and financial advice to determine the value of any taxation benefits.
When times are tough in the property market, investors stay away. However, if you think about property as a medium- to long-term investment, you can gain heart. While the property market in Australia rises and falls regularly (which is why we talk about property cycles), the lows are never greater than the highs. Anyone in the real estate industry will tell you that, historically, property prices double (more or less) around every eight years. If you hold on to your investment property for eight to ten years, you will have built up enough equity in the property to sell it and pay off your primary home loan.
Not convinced? Read on to learn how a young couple used their investment property to help pay down their owner-occupier loan.
Case study 1: Land-and-build
Karen and Michael* were paying off a mortgage on their home. In addition, they purchased a land-and-build package in Nowra, two hours south of Sydney in NSW, as an investment. The land purchase price was $127,000 and the construction cost to build a duplex was $350,000 for a total package price of $477,000. They built a three-bedroom property and a two-bedroom property.
Karen and Michael borrowed the full $477,000.
- Loan term: 30 years
- Interest rate: 4.5%
- Repayment monthly: $1,789
- Rent three-bedroom monthly: $1,517
- Rent two-bedroom: $1,300
- Total rent: $2,817 each calendar month
- Total outgoings: $192 a month ($2,300 a year)
- Costs included letting agents, maintenance, rates and insurance.
Return on investment
- Rent: 2,817
- Less repayment: -1,789
- Less outgoings-192
- Surplus each month: $836
Karen and Michael used three strategies to pay off their owner-occupier debt:
- They funnelled the surplus of $836 into their owner-occupier home loan, saving them 13 years and $115,000 in interest over the loan term.
- They deposited the rent into their owner-occupier loan offset account, thus saving them interest on their home loan until the repayment was due.
- They took advantage of tax savings in the form of depreciation benefits to reduce their taxable income and save thousands in tax.
When the property appreciated in value two years later, they sold it for $680,000 and paid down their owner-occupier home loan with the profit.
Note that Karen and Michael benefited from purchasing a brand-new property.
There are several advantages of buying a brand-new property or brand-new house-and-land package.
- Tax benefits
The allows more generous deductions for new properties, and you can depreciate the home. This means you’ll gain an increased negative gearing benefit with less tax payable.
- Stamp duty discounts
There are stamp duty discounts on new properties; in some states, there is no stamp duty at all.
- Low maintenance
As the property is brand-new, it should need less work than an older property.
- Lower vacancy rates
Most tenants prefer to rent a brand-new home with modern fixtures and fittings.
Could you buy an investment property?
Do you have a home with where you hold some equity? Do you have a stable job? Are you managing your budget prudently? If you can say ‘yes’ to all those questions, you won’t find it too difficult to buy an investment property.
Case study: Releasing equity to buy investment property
Jessica and Damian*, a young couple from Nowra in NSW, were both on modest incomes of around $50,000 a year each. We helped them buy their first home.
After three years, their circumstances improved and their primary residence had gained in value. We helped them to release equity from their current home to fund the deposit and costs on a modest $400,000 investment purchase – a three-bedroom house with a two-bedroom self-contained granny flat that could be rented out separately. The rent from both properties mean Jessica and Damian don’t need to use any of their own savings to top up the mortgage repayments on the investment property. Jessica and Damian intend to rent and hold until the property appreciates in value, at which time they will sell it, use the proceeds to pay down the mortgage their primary residence, then purchase another investment property.
What are the risks?
Property over the long term is a demonstrated way to create wealth. However, if it has a drawback, it’s that it isn’t as liquid as shares. If you need to realise some cash, it isn’t like you can auction off a room. That said, trying to guess the stock market without your own patented and proven algorithm is, in my opinion, a far riskier proposition.
Naturally, with any large outlay, there are risks involved. However, as long as you have a well-structured mortgage, and a buffer in case you’re faced with a disaster that insurance won’t cover, a second property that you rent out with a ‘sit and hold’ approach can be a fantastic vehicle to help you pay off your owner-occupier mortgage sooner.
Need help buying property?
We’re here to help. Call us on 1300 397 287 (+61 3 9956 9321 if you’re outside Australia) or email us using the contact form.