Part 3: Which is better for financial freedom - buying a home or renting and investing?
16 Sep 2013
By Darren Higgs
I have a 'friend' who was very, very lucky that his mother was willing to assist him in getting a financial headstart (thanks, Mum). My friend was also very lucky that the father of his girlfriend at the time was also very helpful with financial advice (thanks, Charlie). Robert Kiyosaki has a book, "Rich Dad Poor Dad". My friend will title his book, "Awesome Mum and Caring Financial Mentor". His story follows.
My friend always had a good work ethic. When he left high school, he worked full-time in the Treasury Department of a bank, whilst working part-time at KFC (only so he could take the food home at the end of each shift) and studying accounting part-time too.
He was prudent with his cashflow and each month, he invested a set amount into managed funds via a regular investment plan. He learned to live off the remaining income which gave my friend a savings history that would become valuable later on. It also helped him build up a decent deposit.
Buying investment property
Charlie forced my friend to buy his first investment property at age 25. The banks were willing to lend the monies because he could demonstrate a savings history via the regular investment plan. He had also saved enough to cover 20% of the purchase price, so he could avoid the lenders mortgage insurance. Donald Trump was getting nervous, as there was a new property tycoon in town!
Charlie then cajoled my friend into buying his second investment property a few months later. The banks again were willing to lend, as my friend now had a good credit history with the loan repayments from the first property and they could use his initial property as security.
However, purchasing a second investment property in such a short time meant my friend did not have the necessary deposit or security for both loans. This is where his Mum was really helpful. His Mum allowed him to use the family home as security and acted as the guarantor even though my friend had the necessary income to make the repayments. This allowed him to get into a good investment that he otherwise could not have.
Further to the above point, Donald Trump was really starting to shake in his $10,000 boots, as my friend had developed some property momentum!
Over the years
My friend made sure he insured himself properly, especially since his Mum was guarantor for the loans. My friend obtained income protection insurance, trauma insurance, total and permanent disablement insurance and life insurance. By this time he had finished his studies and started his career as a financial adviser so he understood the importance of insurance immediately.
My friend saved hard over the next year to reduce the total loans to less than 80% of the two properties he held. He was also helped by the fact that the properties increased in value allowing him to remove his Mum as guarantor on the investment property loans after 18 months. This meant it didn't become a lifelong commitment for his Mum.
Now as a financial adviser
My friend, now a financial adviser, learnt about cash flow, risk management, diversification and investment fundamentals. He does not want to argue which is better between property or shares, as he likes and retains them both, however, his personal preference is towards shares. Thus, he began gearing into shares. Donald Trump breathed a sigh of relief and he passed the butterflies in his stomach to Warren Buffett!
The usual way of gearing into shares is via margin loans. While margin loans are suitable for some clients, the higher interest rates on margin loans can eat into the investment returns. Instead, my friend geared into shares using home mortgage rates. How did he do that when the banks do not like using shares as security?
It would not have been possible if he did not have the two investment properties as security. The banks are always willing to lend up to 80% (and often times more) on property they hold security over. Since the banks had my friend's two properties as security, he had reduced the loan balance and the properties had grown in value, it meant that he could borrow against this equity to gear into shares.
To this day, my friend still gears into shares when the opportunities are there. In order to create the equity, his beautiful wife and he direct 25% of their net income into investments and 25% into reducing the tax-deductible debt.
While this might sound like a lot of income going towards investments and debt reduction, it is easier now as their investment income is working for them. They are on the right side of the compounding returns.
This friend and his beautiful wife are currently looking for their dream property. As they have saved for their dream home in a non-traditional way, they will be able to sell their existing investments and pay cash for the property. They will never have a home mortgage, meaning no non-deductible interest expenses. They will have to pay capital gains tax on the investments, but this is cheaper than getting a mortgage. Plus, as they now have an unencumbered property, they can use this as security for gearing into property and shares in the future. They will be age 40 and own their dream home outright, in their ideal suburb. How good is that?
My friend was fortunate and was not asked by the banks to reduce his loans, which they can do if a property price falls and there is insufficient equity. This would have been a disastrous set back if my friend could not provide additional security or did not have a big enough cash buffer. Of course this is not the only risk, and my friend understood that any investment involves risk and he thought about risk carefully whenever he thought about a new investment, and got financial advice.
How can you achieve owning your dream home?
All of the above is achievable. You just have to be willing to think outside the square and plan. You need to understand how cash flow can work in your favour and also understand YOU, as emotions can derail any financial plan.
If you wish to own your dream home as soon as possible, please come in and have a chat to any of the Shadforth Financial Group advisers. We can provide you with the necessary plan to achieve your aims.
As a special offer, I will also introduce you to 'my friend' who can provide you with the simple spreadsheet he used to achieve his aim. It is a great way of staying on track!
To learn more about Darren, view his online profile.
If you are seeking financial advice please contact us on 1300 308 440 or enquire online.