Loan To Value / Debt to equity ratios

[MadMax]

Thanks Graeme. I've got a lot out of this discussion - conformation that we've taken the right path with P&I loans and maintaining LVR under 60%.

Why not interest only and have a offset or revolving account? Gives you flexibility. Forces you to pay it down?

[orion]

Thanks Graeme. I've got a lot out of this discussion - conformation that we've taken the right path with P&I loans and maintaining LVR under 60%.

Well done Donna, good to hear that

[orion]

Why not interest only and have a offset or revolving account? Gives you flexibility. Forces you to pay it down?

Why not?
It doesn't force you to pay it down at all.
95% of people wanting to do it that way fail.
They see the limit of the line of credit as a target in most cases, then if they get properties revalued, increase the limit.

[snobilo]

While on a steady consistent wage I find P & I loans convenient and stress free when fixed, I know exactly whats coming in every week and exactly whats going out allowing for a fudge factor. The thought of an offset account is nice but dangerous if you lack self control I believe.

In terms of LVR I've gone the risky route by having my mum "gift" me the deposit ( I still pay her back ) in the banks eyes I have 20% but in reality at about 95% now. However I have ensured that I can still cover all costs if rates rise to 12% and have enough savings for "most" spontaneous emergencies.

This wouldn't appeal to most people but only time will tell as with the next rent increase for my auckland apartment and flat mates at my PPOR everything will be cash flow positive (if interest rates remain below 5%, we will see).

When the market does fall again it will be interesting to see how bad it effects Aucklanders.

[GenY]

Hi Orion,

Can you clarify. The LVR calculation -is that based upon all properties including your PPOR across all banks that you use?

I have 5 properties in Auckland with one bank at <50% LVR with under $1.5 mil in debt. These have been on P&I from day 1 (started investing in 2008/9). Very glad I never got into the IO thing- didn't sit well with me growing the debt and not paying it down. I know some people have the "buy 10 and sell 5 in 10 years" plan. I plan to never sell any doors. My four kids and future grandkids will get them eventually. These five doors are cash flow neutral so income covers expenses.

I have a LOC on the PPOR which I have used to buy the last two rentals. The LVR on the PPOR is 30% and will start paying this down with my other business profits this year.

I have

[GenY]

I have one other property with another bank at 75% LVR which is rented but one day will be the new family home.

So overall across all banks and 7 properties about 50% LVR.

I really like your threads Graham.

Beauty with property is there are different strategies for different people in different life situations.

Most people my age (nearly 35) have no idea about money and no plan about the future.

All the best

[Wayne]

Why not?
It doesn't force you to pay it down at all.
95% of people wanting to do it that way fail.
They see the limit of the line of credit as a target in most cases, then if they get properties revalued, increase the limit.

While I agree with this you always make it sound like a rule.
People need to understand what sort of person they are - they need to have a good honest look at themselves.
Are they a saver or a spender?

I brought my 1st house at 22 - seemed like a good idea at the time.
P&I - just paid what I needed to but it was a 15yr mortgage.
High inflation, high interest rates, high wage increases - on a pigs back!
When I got married and I built out 1st house (my 2nd) I had a 15yr mortgage again but worked out what I needed to pay to pay it off in 8 years (just a target I picked).
Was well on track when we moved (to another city).
To cut a long story short we rented for a while, while building a house - had cash to build.
After we moved in mortgage free I decided that we could live OK while paying $250/wk rent (a few years ago and quite a bit at the time) so I'd save that now instead of spending it.
And what is what we have done ongoing - always save the equivalent of a weeks rent minimum.
So I don't have a problem with IO loans - I know what sort of person I am!
But you have to be honest - have a look at your bank balance!

[orion]

Hi Orion,

Can you clarify. The LVR calculation -is that based upon all properties including your PPOR across all banks that you use?

I have 5 properties in Auckland with one bank at <50% LVR with under $1.5 mil in debt. These have been on P&I from day 1 (started investing in 2008/9). Very glad I never got into the IO thing- didn't sit well with me growing the debt and not paying it down. I know some people have the "buy 10 and sell 5 in 10 years" plan. I plan to never sell any doors. My four kids and future grandkids will get them eventually. These five doors are cash flow neutral so income covers expenses.

I have a LOC on the PPOR which I have used to buy the last two rentals. The LVR on the PPOR is 30% and will start paying this down with my other business profits this year.

I have

Hi Yes, the LVR is across all properties and banks.

[orion]

While I agree with this you always make it sound like a rule.
People need to understand what sort of person they are - they need to have a good honest look at themselves.
Are they a saver or a spender?

I brought my 1st house at 22 - seemed like a good idea at the time.
P&I - just paid what I needed to but it was a 15yr mortgage.
High inflation, high interest rates, high wage increases - on a pigs back!
When I got married and I built out 1st house (my 2nd) I had a 15yr mortgage again but worked out what I needed to pay to pay it off in 8 years (just a target I picked).
Was well on track when we moved (to another city).
To cut a long story short we rented for a while, while building a house - had cash to build.
After we moved in mortgage free I decided that we could live OK while paying $250/wk rent (a few years ago and quite a bit at the time) so I'd save that now instead of spending it.
And what is what we have done ongoing - always save the equivalent of a weeks rent minimum.
So I don't have a problem with IO loans - I know what sort of person I am!
But you have to be honest - have a look at your bank balance!

Sounds like you are very good with money Wayne, so makes it a lot easier to use I/O if you can pay them down.
I would still use P & I personally, just makes the whole lot so much easier, and I can see the debt coming down every month without having to use money from somewhere else to pay down principal.

[The_Dog]

Hi Sakura,

Happy to explain.

It’s more than just capital house prices falling. It’s when multiple things happen at the same time.

Let’s say you have 2 properties at 65% LVR, borrowings of 500k, and they are covering themselves with the rent, i.e., your overall position is cash-flow positive (say 4k a year).

You’re pretty happy, life if good. The market is rising and you feel invincible.

You buy another house, taking 100k equity out of your existing properties, borrowing a further 400k. So you now have a portfolio value of 1.27 mill and debt of 1 mill, an LVR of 78.7%. Still under the bank criteria of 80% and you own 3 properties. Unfortunately your positive cashflow is now zero, but you have a good steady job…. so you’re comfortable with that. Your loans are all locked down at 6.5% so there is security / certainty there as well 

The market then starts to turn and hard times hit. Remember, hard times hit everyone, so a lot of tenants can’t afford rent, and move back with their parents, or in with relatives. Your properties are not renting out easily because they are dated, need new bathrooms and kitchens and a paint throughout because there are less tenants out there, and only the best presented properties are renting. You need to spend 60k on reno of 2 properties. Luckily your house prices have gone up a bit (in the tail end of the boom) so you’re able to raise a line of credit. Property values now 1.34mil, borrowings 1.06mil, 79% LVR, so hanging in there.

OK, so now the market really turns, it’s only 15 months since your 3rd property purchase. House prices drop 10%, which is not a lot, not so bad. Your fixed term loans have expired, and to your horror the best rate you can get now is 9.7% fixed for 12 months. Rates have gone up, insurance is up (because of the earthquakes!), and the 3rd property really needs a reno now to attract decent tenants!!

So, in 15 months you have gone from 65% LVR and $4k positive cashflow to….. 87.9% LVR and (at least!!) $33,920 Negative cashflow. That’s just the effect of interest payments, not to mention the rates and insurance!

And then you lose your job.


These are realistic figures. The interest rates are examples real examples from 2006/2008. As I said, things can really move fast, and it’s a double whammy with house prices coming down and expense going up.

I have not mentioned the bank changing policy, or 1000 other things that can impact your investing. I’ve kept it pretty simple..

Not meaning to scare people. It’s just the reality. Part of the good times / bad times cycle.

Before you purchase another property (or your first) – do what is called ‘Shock testing’ of your situation :

If interest rates went up 3 %, would I manage
If house prices came down 15%, would I manage
If I lost my job, what effect would that have
If we have another child, what would I have to change….

Run the figures…..

TD

[orion]

Hi Sakura,

Happy to explain.

It’s more than just capital house prices falling. It’s when multiple things happen at the same time.

Let’s say you have 2 properties at 65% LVR, borrowings of 500k, and they are covering themselves with the rent, i.e., your overall position is cash-flow positive (say 4k a year).

You’re pretty happy, life if good. The market is rising and you feel invincible.

You buy another house, taking 100k equity out of your existing properties, borrowing a further 400k. So you now have a portfolio value of 1.27 mill and debt of 1 mill, an LVR of 78.7%. Still under the bank criteria of 80% and you own 3 properties. Unfortunately your positive cashflow is now zero, but you have a good steady job…. so you’re comfortable with that. Your loans are all locked down at 6.5% so there is security / certainty there as well 

The market then starts to turn and hard times hit. Remember, hard times hit everyone, so a lot of tenants can’t afford rent, and move back with their parents, or in with relatives. Your properties are not renting out easily because they are dated, need new bathrooms and kitchens and a paint throughout because there are less tenants out there, and only the best presented properties are renting. You need to spend 60k on reno of 2 properties. Luckily your house prices have gone up a bit (in the tail end of the boom) so you’re able to raise a line of credit. Property values now 1.34mil, borrowings 1.06mil, 79% LVR, so hanging in there.

OK, so now the market really turns, it’s only 15 months since your 3rd property purchase. House prices drop 10%, which is not a lot, not so bad. Your fixed term loans have expired, and to your horror the best rate you can get now is 9.7% fixed for 12 months. Rates have gone up, insurance is up (because of the earthquakes!), and the 3rd property really needs a reno now to attract decent tenants!!

So, in 15 months you have gone from 65% LVR and $4k positive cashflow to….. 87.9% LVR and (at least!!) $33,920 Negative cashflow. That’s just the effect of interest payments, not to mention the rates and insurance!

And then you lose your job.


These are realistic figures. The interest rates are examples real examples from 2006/2008. As I said, things can really move fast, and it’s a double whammy with house prices coming down and expense going up.

I have not mentioned the bank changing policy, or 1000 other things that can impact your investing. I’ve kept it pretty simple..

Not meaning to scare people. It’s just the reality. Part of the good times / bad times cycle.

Before you purchase another property (or your first) – do what is called ‘Shock testing’ of your situation :

If interest rates went up 3 %, would I manage
If house prices came down 15%, would I manage
If I lost my job, what effect would that have
If we have another child, what would I have to change….

Run the figures…..

TD

Very well explained, pity more people don't think that way.

[OneStepCloser]

Hi TD,

What a great post! Thanks!

[snobilo]

Fantastic read TD.

[Grads]

Great post TD! Many investors don't plan for worse case scenarios and plan for A,B,C,D events that can occur.

Prices (even in AKL) don't always go up, busts follow booms, business and property are cyclical.

New investors (those that haven't invested through a complete property cycle) should keep in mind that's banks are great to deal with - when values are rising however lending rules change when the market turns and outlook is negative.

[The_Dog]

No worries all. You're welcome.

I like to provide a contrast to all the hype, "young couple amass 2.5 Million dollar portfolio in only 2 years", "draw down your equity and go again!!"

What is wrong with buying a house every 2 years, getting 5, hold for 25 years, and then live of the (mortgage free) rental?

There is the thrill of the chase / race, but (hardly) no-one talks about the downside. I got caught up in it myself, so I'm just letting other people know so they can hopefully take a more cautious (and sustainable) approach.

TD