12 Aug Re-finance pros and cons – Ian Rodrigues
Refinancing your existing portfolio to help it grow the number of properties is an option many investors are exploring so we talk to Ian Rodrigues about the pros and cons and what you should be aware of before doing it.
Kevin: Well, amidst the rising interest rates and title-lending regulations, investors might decide to opt to refinance their property to access additional funds and ultimately continue growing their portfolio. Is this a strategy that could work for you, refinancing your way to your next property?
Ian Rodrigues joins me to talk about this. G’day, Ian. How are you?
Ian: Pretty good, Kevin.
Kevin: What are the pros and cons of this, and what are the steps to doing it, Ian?
Ian: Refinancing your way to the next property has always been a good strategy for investors. The numbers say that most investors do nothing. The next biggest group has one property, and there are very few people that move onto the second, third, fourth, and fifth property. That’s from data that the ATA releases about how many tax payers have investment properties in their tax returns, so it’s pretty reliable data.
What that tends to suggest is that a lot more people get to one but never actually get to the next one. So the key for people looking to get to the next property is that usually they borrow the maximum that the bank would have given them – maybe, say, 80% – against their investment – and something has to have changed in the property’s value, or the debt has to be decreased so that the, with the loan ratio, there’s some equity in that property.
That, of course, is then a good time to use that equity by refinancing, either with the same bank or with a new lender, to give yourself the deposit potentially for the second property.
Ian: Now, having said all that, is that a good idea? It entirely depends on your ability to fund those loans – if you’re missing a tenant or you lose your job or something like that. So for any strategy that included borrowing money, you need to be aware of all the risks that go with borrowing money, which I’m sure people are aware of. It’s not the unusual ones. It’s the basic ones. If you don’t have the income or you don’t have a tenant, if your borrowing is on a shoestring to be able to meet the commitments, you need to be very careful of doing that because that’s how you lose money on properties, being a forced seller.
Kevin: Yeah. That’s one of the risks: you overextend and you can’t afford it.
Ian: It’s the major risk. People worry about interest rate rises and all that. My advice to people – the banks seem to be finally applying this – is that, if the rate was a couple percent higher, can you still afford it? If that’s a problem for you, you are too highly [2:39 inaudible].
Kevin: So with that strategy, you can almost say, “That’s going to be my benchmark. I have to factor in a two or even a four percent increase in interest rates. What will happen if I have to pay that?”
Ian: Well, I think the banks were going through a period where they probably we’re as focused on that. They now are; for example, a lot of things that are going on in the marketplace. So they certainly take into account what might happen if rates were higher. That’s why I find all the oxygen about rates might move a quarter of a percent. They haven’t for a couple of years now. A quarter of a percent? If you’re worried about that change, you really are too [3:19 inaudible]. I’m talking about 200 basis points, not 25.
Now, whether the 200 is the right number or not is a matter for debate amongst some academics somewhere. But practically speaking, the borrower needs to be comfortable that if rates went up or they had a change in their income or didn’t have a tenant, how long they have before they’re going to run out of cash and build a significant buffer in, because those things can and do happen.
Kevin: While I have you there, I wonder whether you can answer a question from Mike, who wrote in and said, “When I made a redraw from home loan, I paid $8,500 extra in repayments. So my redraw capacity was $8,500. However, when I made the redraw a month later on my statement, they had increased the normal weekly loan repayment from something like $420 a week to $455, which was a bit of a shock at the time. So I rang them and asked them why, as all I did was tag back the extra payments on top of the normal payments, as I thought the redraw was designed to do. They explained that, because I had made a redraw, for some reason they had to increase the normal repayments I had been making for years to compensate for the loss of the $8,500 I had taken out. Can you please check on this? This is a very important point.”
What’s your response to that, Ian?
Ian: I think Mike has been a little bit caught in not understanding how the banks look at loan repayments. Somewhere in the fine print in these loan contacts that we sign that I reckon no one reads is how they calculate repayments. I dare say the bank wouldn’t get this stuff wrong. They may get other stuff wrong, but this is something they would generally get right.
The repayment is calculated on the total bit, and the repayment is calculated on the term of the loan. So with his total debt level, regardless of whether it’s in redraw or on the loan balance, they’re looking at the overall debt and calculating what that might be.
Now, these policies can vary, I would imagine, from bank to bank and from loan to loan. It’s more important for the borrower to understand, with $420 a week, how long it’s actually going to take to pay off that loan. A standard reference point when they’re handing out loans is generally 25 or 30 years. Some people still have interest-only loans. Of course, they’ve become very expensive in the current market. You want to understand when you’re going to get rid of this debt. To me, that’s the most important point for Mike. The repayments are what they are, but when does he want to get rid of this debt.
Kevin: Something that should be clearing up, yeah.
Ian: Yeah. Or does he want to save up in the redraw to get into his next investment property? I don’t know. That’s the key. I think people need to be much more in tune with their debt, how it’s going to be and what can happen to it in the future. All those issues are pretty important.
And we’re in an environment, Kevin, too, where borrowing from a bank used to be a simple, relatively straightforward process and the banks would [6:43 inaudible]. It’s changing before our eyes.
Kevin: Yeah. Very good, mate. Thank for bringing us up to date on that, Ian Rodrigues from the Bishop Collins group. Mike, thank you for your question as well. Ian, thanks for your time.
Ian: Great, Kevin. Talk soon.