Ingredients Of A Good Personal Financial Plan – Part 3 Mortgages
MBA, BSc, DipFP
Financial Planner / Managing Partner
Ingredients Of A Good Personal Financial Plan – Mortgages
The way you structure your mortgage, or mortgages, can have an enormous effect on the success of your personal financial plan.
Not only will it impact your cash flow, but it can have far reaching consequences on your tax position, even your ability to respond to opportunities and changing market conditions.
With interest rates at a record low and expected to stay that way for at least three years[i], there couldn’t be a better time to make sure your mortgages are set up to help you succeed. So what are some of the important factors to consider, and traps to avoid?
Why Your Mortgage is so Important
In the last issue of our Ingredients of a Financial Plan – Property series we talked about the importance of property in your plan.
Only the lucky few are in a position to buy a property without taking out a mortgage and since your own home is most often the single largest portion of your overall financial position, this makes your mortgage the single biggest financial transaction most people are likely to make. Best get it right then!
If you read our article How To Lower Your Mortgage & Reduce Your Debt, you will already have a good handle on what features to look for in a mortgage for your family home.
But it is not just your family home on which you might take out a mortgage. Investment properties can also make up a large part of your financial plan, and investment mortgages are very different to owner occupied mortgages. One of the key differences is the way the repayments are structured.
Principle and Interest vs Interest Only
Whilst there are many ways to structure a loan, there are two fundamental choices before you get down to things like interest rates and offset accounts.
Loans are repaid either as Principle and Interest or Interest Only.
Owner Occupied homes are most commonly Principle and Interest, whilst many Investment Mortgages are Interest Only. There are pros and cons for both.
Principle and Interest
With this type of loan, as the name implies, you pay a portion of the principle, plus interest, in each instalment.
The primary benefit of this structure is that each payment reduces the amount of the loan, therefore the amount on which you are being charged interest.
It also means each payment is increasing your equity in the property, over and above the increase in its value. Most Owner Occupied Mortgages are set up as Principle and Interest.
Generally, Interest Only loans are used for investment properties. This is because a loan on an investment property can provide you with tax deductions that are not available to you on your Owner Occupied mortgage.
Due to this, in most circumstances, it is in your best interest to pay off your home mortgage first, but this is dependent on your financial situation.
It is also possible, though not all that common, to take an Interest Only option on an Owner Occupied loan for a short period of time. There are a few of instances where you might want to consider this option and I will outline one below.
At the outset of the loan an Interest Only option can help with affordability as the repayments are lower. This can also be useful when you have reduced income, such as one partner taking parental leave for a period of time.
However, this will increase the total interest you pay, can extend the term of the loan, and will reduce the speed at which you build equity in your home.
Investment Mortgages – Cross-Collateralisation vs Stand Alone Security
Often times when you are looking at taking out a mortgage for an investment property you will consider using the equity in your family home as collateral on the investment property.
How you go about structuring this can have long ranging effects on your finances and needs to be carefully considered.
Broadly speaking, unless you have a lump sum of cash available, you have two options; Cross Collateralisation or Stand Alone Security.
This is where the loan is secured against both the equity in your home and the investment property itself. This type of security is generally best used when your aim is to keep the property for upwards of 10 years, and you don’t intend to buy an additional investment property.
This is chiefly because cross collateralisation can be difficult to untangle if you wish to sell a property and the more properties you have, the more tangled the web becomes.
With this structure, a market downturn can cause a chain reaction, as each property is secured against the last. In this case, selling one property can mean you have to completely restructure your financing, which can be costly and time consuming.
However, this type of structure can mean you can sometimes negotiate a lower interest rate and it can provide you with some tax benefits.
Stand Alone Security
Stand Alone Security still uses the equity you have in your home, but only to provide you with a deposit for the investment property. The balance of the investment property is funded by a loan secured against that property alone.
The benefit of this strategy is that either property can be sold, and the relevant loan paid out with the proceeds of the sale, without affecting the other property. This provides you with much more flexibility in your decision making.
There may also be lower costs in relation to mortgage insurance or in moving your funding to a different lender should you decide your current lender is no longer appropriate.
Get the Right Advice
Once you have decided to invest in property, whether a home to live in or an investment, it is important to get trustworthy advice on the best structure for you.
There are pros and cons to any approach, and it is important to talk to someone with a good understanding of your overall financial position and future plans, as well as the options available to you. The right decision could make all the difference.
If you would like advice on the best mortgage for your needs, and how to structure it to maximise your financial potential, please contact us on 02 9976 3388 or click below and we’ll be in touch.Interested in knowing more?