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Why you should be paying Principal on your Rentals!

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  • Why you should be paying Principal on your Rentals!

    Why you should be paying Principal on your Rentals!


    Long term, do you want Passive Income from your rentals?

    What is the easiest way to achieve this?

    Obviously that is easy - it's to have no mortgage. One of the easiest strategies to achieve passive income from your rentals is to make Principal and Interest repayments, and long term pay off the mortgage. Sacrificing a little bit now, saving a little harder, and budgeting a little more, can have huge benefits later on and can really help to set you up for your retirement.

    How is paying Principal possible?

    It’s human nature to spend all that you have available. So if you earn $800 in your hand each week, the $800 per week will generally disappear. Often people don’t know where their income goes, but because it's there, they buy little extras they don’t really need. But if the net pay was only $750, you would probably still survive. You might have a few less drinks, lunches and luxuries, but this would force you to manage your money better and adapt to having slightly less. So, working on this principle, if you were to set up an AP for the $50 per week to go towards your rental to pay down some principal, then you probably wouldn't even notice the difference of a little bit less in your spending account each week.

    Over 10 plus years, the small principal repayments will add up to a lot. You start saving interest on the loan your have repaid, so slowly the interest gets less and less. Then you have more cash free, so can repay more in principal. So its all about getting into this winning cycle.


    Your available cash Increases

    If you just allow the pay rise, finished loan repayments, or tax cut money to sit in your spending account, it’s going to disappear. On paper you are earning more and have more cash, but you will naturally adjust for this and it will disappear on unnecessary extras. So instead:
    • If you get a pay rise: Work out the extra pay and increase the AP to your rentals or home loan to pay off the mortgage quicker.
    • If you finish paying off an HP or car loan: Set up an AP for the same amount to your rentals or home loan to pay off the mortgage quicker.
    • On 1/4/18, if tax rates change: Work out your extra net pay, set up an AP to your rentals or home loan to pay off the mortgage quicker.


    But, but, but………… the “tax benefits”

    I hear this comment all the time. Yes, it is a slight benefit to pay off your personal home loan quicker. But most of the time the money just gets wasted and doesn’t go to either the home loan or the rental. Also the tax benefits are often tiny. I looked at this in more detail in my 21/3/17 blog, and on a $500,000 rental loan the difference in tax was only $292 per year approximately over five years!

    Hopefully this helps you to pay off your rentals and obtain passive income long term!
    Book a free chat here
    Ross Barnett - Property Accountant

  • #2
    It's a sensible point, spend less and save more.

    But doesn't consider that there are often better uses of the capital than paying down rental principal.

    For one thing, there's the obvious - paying down private debt, which is almost always a higher cost after tax considerations.

    Or, there's investment in other things - another rental, some shares, a new business venture.
    AAT Accounting Services - Property Specialist - [email protected]
    Fixed price fees and quick knowledgeable service for property investors & traders!

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    • #3
      1) Personal home repayments vs rental - As I put in my post and older post, the advantage of paying down your personal home vs rental, are actually tiny when you look into the numbers. Also many say they will do this, but the extra money just disappears and doesn't reduce the personal debt either.

      2) Long term aim of passive income - For most people they don't have other business ventures. Property investment is their retirement plan. Often if investors use funds on more risky projects or ventures, they often lose these, and end up in a worst position, with no business and still a negative rental. Whereas paying down the mortgage is extremely safe and if done over the long term results in passive income.

      Ross
      Book a free chat here
      Ross Barnett - Property Accountant

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      • #4
        Over 10 plus years, the small principal repayments will add up to a lot.
        That is true, but you don't see the benefit of it; it is compulsory saving.

        25 years of 5% on $500,000 P&I is roughly $490 a week. As time goes on it goes from $1 Principal and $489 interest to $1 Interest and $489 principal, but until the mortgage is totally paid off, you give your $490 to the bank.

        This has tax implications also - the tax on close to $490 per week in the final years (when there is less interest to offset it) starts to add up, but you can't access the cash flow to pay the tax.

        Yes, I know that rent will increase over time, so $490 should be a lower and lower proportion of the income, but sometimes it doesn't feel that way!

        Also, there are reducing mortgages, where you pay a fixed amount of principal each payment + the interest, and the payments start higher but reduce as time goes on.
        DFTBA

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        • #5
          If you're good at treating your investment like a business, building up revolving credit gives you control of the cash and the same benefit on interest.

          I went to the BNZ a few months ago and asked for an amount approximately 2% of the value of the house to do some renovations. My LVR is fine. They wanted a registered valuation done through their new panel, updated everything, it was like I had walked in off the street without showering. Sod that.

          I'm an outlier tho, most folks are less active so paying down debt is fine I guess.
          Free online Property Investment Course from iFindProperty, a residential investment property agency.

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          • #6
            Originally posted by Nick G View Post
            If you're good at treating your investment like a business, building up revolving credit gives you control of the cash and the same benefit on interest.

            I went to the BNZ a few months ago and asked for an amount approximately 2% of the value of the house to do some renovations. My LVR is fine. They wanted a registered valuation done through their new panel, updated everything, it was like I had walked in off the street without showering. Sod that.

            I'm an outlier tho, most folks are less active so paying down debt is fine I guess.
            Hi Nick,

            As you put, you are very active, so a little different to most investors. But paying down a little principal to reduce your risk and to long term improve your cashflow doesn’t hurt. While interest rates are in the 4’s it makes sense, as you should have some extra cash or buffer.

            Ross
            Book a free chat here
            Ross Barnett - Property Accountant

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