Wednesday, 6 June 2007

Money Matters #1 - Investing on a single or low income

I am an avid reader of the Sun Herald finance section, Money Magazine and, occasionally, other financial publications. For a non-capitalist, I have a real interest in money. I don't think I really want to make heaps of it, but I like the challenge of finding good investments and stretching the family income. Having said that, I don't invest very much. A case of, if I had any money, here's what I would do with it. But like all good financial managers, we do have a few small investments and hope that one day we can add to them. Once the kids grow that is. If I ever get back to full-time work that is. One day, that is.

In the meantime, I have a plethora of good reading material around the place. I thought I would write up some key points, rather than have to keep the paper-cpoies. A way for me to refer to them, without having to physically locate them. This house is getting way too small! Please note: if you are not me, and you are reading this, I am NOT a financial adviser and I take NO responsibility for whether or not these tips are helpful. I am just jotting them down in my own way so that I can refer to them again and make a decision about their usefulness.

So my first attempt at this comes from an article by Terry Ryder, published in this month's Australian Property Investor magazine, called (aptly) Investing on a Single or Low Income.

There are plenty of options for wannabe investors whose incomes present barriers to getting into the property market (I'm listening, Terry...). Investing is challenging for people on a single or low income, but not impossible. Especially if you have equity in your home. Low income earners cannot afford to take big risks and the reality is they have smaller borrowing capacity, but that doesn't mean you can't put together a property portfolio over time. It won't be high-end property, or even middle-of-the-road  property and you may not be able to buy lots of properties, but you will be able to create a property portfolio. (Still listening Terry... get on with it).

Here's a short-list of important considerations for you if you are in this situation:
  • Have realistic expectations of what you need: aim for lower-end properties. You don't need 100 properties, just a couple will do if you can sit on them and let time do its thing.
  • Check out 'ugly duckling' suburbs: every city, including Sydney, has areas with affordable homes. But don't just stick to cities, the whole of Australia is your market. Ugly duckling suburbs have cheap homes but also tangible reasons to grow and evolve into better locations. It may not be near where you live, or indeed somewhere where you would like to live, but it will be cheaper and will have better returns. Also think about units and townhouses, rather than a free-standing house.
  • Find positive cash flow property: try to find property that earns enough rent to cover the costs of owning it (positively geared) or close to cost neutral. Apparently it is still possible, although not as easy as it used to be, and will help with securing cash from a bank. This is not without its risks though. Most of these properties are in one-industry towns (like mining towns) where values are dependent on the longevity of the resources boom, and the entry prices are now becoming steep. Studios and one-bedders in the city often attract 7-8% returns in major cities, but they are hard to get investment loans for. Banks are reluctant to lend on properties under 50 s.m.
  • Understand what matters to financiers: It is not how much you owe on credit cards that matters, but the total limits of all the credit cards you have. Get rid of unnecessary credit cards and pay out any other loans. The less debt you have the better when applying for an investment loan. You don't need a 20% deposit but this will impact on your interest rate and the fees the bank charges. And there's stamp duty, mortgage insurance and legals to consider. Remember, you need to be able to pay back the money you borrow. Don't get in over your head. You need a regular, steady income.
  • Consider a shared equity loan: These are pretty new to the market. Buyers can acheive a purchase for less than the full price, they also have to forego a chunk of capital growth when they sell. The bank retains 10/15/20% share of the property but receives up to 40% of the capital growth. These are complicated loans but may be an option if you have no others available.
  • Consider low-doc loans: These loans allow you to state your income and sign a declaration to that effect. The lender then bases their assessment on the stated income figure. Mainly for self-employed people who don't meet usual lending criteria. You need to have been self-employed for 2 years with an ABN. You need to provide 20% equity for low-doc (and 30% for no-doc loans). You can go higher but the interest rate increases too. Use this cautiously though. It is not meant to be a way to borrow more than lending criteria would allow or more than you can pay.
  • Take a longer term to lower payments: 40 year loans are out there and these can springboard low income earners into the market. Longer terms lower the minimum payments on the loan, which may mean you can borrow a bit more, while still having the flexibility to pay back extra on your mortgage (should your situation improve). This may be a stepping stone to a standard-length mortgage after becoming established.
  • Buy property with others: Thought about partnering with a friend or family member to buy property? It is becoming more popular. Partnerships will distribute the liability, but are not without their issues. Address contingencies and I mean ALL contingencies (such as payment of rates, how the property will be managed, how maintenance costs will be paid and what happens if someone decides to sell out). You will need a tenants-in-common agreement. You don't need to have equal shares, one can take 40 percent and the other 60 for instance. You can finance your shares separately, but the partners are jointly and severally liable for the debt. All of it. A split agreement, where you are in control of your part, and they are in control of theirs is best practice. That way you can pay off your share at any rate you wish. Note: this sort of deal can restrict your future borrowings.
So there you have it. Terry's investment tips for young players. He makes it sound possible (albeit with some rather unorthodox methods), but I still think that with 2 kids, 2 PT jobs and a massive mortgage that I will have to hold onto this information for another day. What do you think? Are you ready to take the plunge?

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