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How To Create A Sound Financial Structure?
A financial structure is simply a plan. An effective financial structure enables you to:
- Leverage your borrowing for maximum wealth building potential, while
- Protecting your home and other assets
One of the things we at Investloan stress to our clients is the crucial importance of structuring your loans for responsible wealth building. It is one of the most important decisions in any investment property purchase.
An ineffective structure, set up to save a few hundred dollars in interest, may inhibit wealth creation, costing you thousands in years to come. It may also impact on the rest of your assets - including the family home. Investloan advises strongly against using your own home as collateral security for your investment property.
 Avoid cross-collateralisation
Major banks, lenders, finance brokers and originators have all promoted 'cross-collateralising' loans, whereby the lender uses all properties mortgaged with it, as security for your outstanding loans. They also attempt to refinance all your existing loans with the one lender.
There are a number of reasons for doing this - and none are for the benefit of the client. The reasons lenders do this, in our view, are:
- It increases the value of the clients' loans - and the lender's fees or commissions
- It 'locks in' a client so that all future housing finance must be obtained through that lender.
- It removes the need to disclose the valuation amount of the investment property, because equity in the family home is used. The property being purchased may be valued by the bank lower than the purchase price being paid, however the other properties already held as security make up the difference.
Here is an example of a cross-collateralised structure:
| |
Property Value |
Lender |
Loan Amount
|
|
| Own Home |
$400,000 |
'Example Bank' |
$150,000 |
Owner/Occupier Debt |
| Investment Property 1 |
$300,000 |
'Example Bank' |
$322,000 |
Investment Debt*
|
| Investment Property 2 |
$300,000 |
'Example Bank' |
$322,000 |
Investment Debt*
|
| Totals |
$1,000,000 |
'Example Bank' |
$794,000
|
|
* includes $22,000 in associated purchase costs.
As you can see by structuring loans against the family home, 'Example Bank' has a mortgage over all three properties, in this very common practice.
Drawbacks of a cross-collateralised structure
If this is such common practice, what is the problem?
- In a default situation, 'Example Bank' would decide which property it will sell to recover its money. This does not have to be your investment property, it could be the family home.
- You are relying on one bank's valuation policy for assessing, and re-accessing, your equity growth. If 'Example Bank' has a very conservative valuation policy, your wealth building will be restricted.
- If 'Example Bank' raises its interest rates or fees, you are affected on all your loans.
- The investment loan amount is higher than the value of the investment property. If the property is sold, 'Example Bank' will need to recoup the shortfall from you, the client.
- All three houses need to be revalued each time you want to increase your loan.
What is the alternative?
The alternative is a sound financial structure, which provides for 'stand-alone' security.
The following is an example of clients purchasing their first investment property.
| |
Property Value |
Lender |
Loan Amount
|
|
| Own Home |
$400,000 |
Westpac |
$150,000 |
Owner/Occupier Debt |
| Investment Property 1 |
|
Westpac |
$ 52,000 |
Investment Debt
|
| Investment Home |
$300,000 |
ING |
$270,000 |
Investment Debt
|
| Totals |
$700,000 |
'Example Bank' |
$472,000
|
|
* To cover $30,000 deposit and $22,000 costs of purchasing an Investment property.
The clients have been forced to use the equity in their own home, as it is their only property asset and source of deposit. However, Investloan has recommended two different lending institutions to protect their home: each property 'stands alone' as security for each loan.
In the following example, the same clients are purchasing their second investment property, assuming that the property market has experienced growth.
| |
Property Value |
Lender |
Loan Amount
|
|
| Own Home |
$440,000 |
Westpac |
$150,000 |
Owner/Occupier Debt |
| Equity Loan* |
|
Westpac |
$ 52,000 |
Investment Debt
|
| Investment Property1 |
$360,000 |
ING |
$270,000 |
Investment Debt
|
| Equity Loan** |
|
ING |
$ 52,000 |
Investment Debt
|
| Investment Property2 |
$300,000 |
Adelaide |
$270,000 |
Investment Debt
|
| Totals |
$1,100,000 |
'Example Bank' |
$794,000
|
|
* To cover $30,000 deposit and $22,000 costs
** To cover $30,000 deposit and $22,000 costs
The clients are using the increased equity in their first investment property to fund the deposit and costs of purchasing their second property. Their home was not required as collateral this time, as there was sufficient growth in their first investment property.
If we reformat our table, using exactly the same financial structure, you can see more clearly how each property stands as collateral for a loan with a different lender.
'Stand-alone' securities
| Own Home |
Investment Property 1 |
Investment Property 2 |
|
Valuation:
$440,000
|
Valuation:
$360,000
|
Valuation:
$300,000
|
|
Lender:
Westpac
Home Loan $150,000
Equity Loan $52,000
|
Lender:
ING
Investment Loan $270,000
Equity Loan $52,000
|
Lender:
Adelaide Bank
Investment Loan $270,000
|
Benefits of the Investloan structure
- Your owner-occupied property (the family home) is not cross-collateralised with any investment property
- Each property is financed by a different lender and relies on its own valuation
- If a lender introduces a new fee or increases rates, you are not affected across all loans
- You can access the equity in each property individually
- Any new purchases are valued separately - not propped up by existing properties. So you will not be duped by unscrupulous property marketing companies
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