Equity and LAQC

[toddncar]

As can see are very 'fresh' to PT.

We currently own a house (GV 440 000) with a 140 000 mortgage and have an option to buy a house at 540 000 (GV) in an area more suited for our growing family.

We have been told by others ( non-professionals) that a) we have good 'equity' in our current house, and b) it would be a very good rental property and c)we should put our current house into an LAQC to maximise tax advantages.
We are a single income family and would not be able to absorb a significant increase in mortgage repayments. We are making fortnightly repayments of $550 on the current mortgage; buying the second house for $540,000 would mean mortgage of $1776/ (for $540 000 at 7.10% for 25years).
We are not clear about the following
1) The role of ‘equity’. For example can our 300,000 equity be used to offset the amount we need to borrow at all?
2) The value of an LAQC for us. For example what are the advantages /disadvantages of an LAQC and can any profits be used to offset the second mortgage.

Any thoughts or comments would be much appreciated,

[CJ]

Your property may make a "good rental" but does it from an investment perspective as well? What would it rent for? What would you originally purchase it for (this will effect depreciation)? Would you manage it yourself or use a property manager?

[toddncar]

Thanks CJ

1. Looking at similar rentals in the area and including servicing (think that's the right term- such as rates; 1 month non-tenancy allowance; house insurance and $1000 for maintainence cost), we think we could have the current house rented reasonably at $460, though have not formally had valued as such. This would allow for a $80 'mark-up' per week.

2. Original purchase price in 2001 was $216 000 (GV Sept 2008 was 440 000)

3. We are looking to manage ourselfs (with lawns managed by tenant), unless advice to a 'newbie' is to go to property managed externally.

Appreciate any further comments with this,

[Keithw]

1) getting Equity out of your property actually means borrowing more, so you still need to account for repayments on the new loan on top of your existing loan. (hopefully most of this is paid for by the rental income)
2) borrowing for a new place for you to live in is not tax deductable, regardless of whether you use your home or the rental as security
3)An LAQC is not required but could have a big advantage in your case as you are on a single income, and i would imagine you would want join ownership of your rental and your home.
With the LAQC owning the rental, the ownership of the property is by the LAQC & the ownership of the LAQC is by the shareholders, thus you might make the shareholding 99 to you (the income earner) & 1 to your partner. This allows the income earner to offset the expected losses of the LAQC against their income.
Without the LAQC, the losses must be split 50/50 between the joint owners, which is useless to the non-income earner.

The second use for the LAQC is to allow you to sell your existing property to it.
The LAQC raises the loan to buy it, and all the interest on that loan is tax deductable (assuming the LAQC is buying it for rental)
This effectively allows you to extract all your money (Equity) out of the existing property & take it to buy your new home, with minimal personal mortgage.
Ultimately your aim is to pay off all your personal mortgage, as it is not deductable, at the expense of the LAQC, which is deductable.

To work out the expected losses, do what you have already done regarding income & expenses, but work on loans by the LAQC of the full amount of the current valuation of the rental. For depreciation, use 3 % of the building value (ie value of improvements on your rates valuation) - that should give you numbers that are close to reality.

In both the case of an LAQC & personal ownership, income/ losses of a rental are transferable to the owners, so a loss helps reduce your tax liabilty on your normal job income, while a profit increases it.
Ideally you want to have the ownership & borrowings structured so that the property makes a positive cashflow week to week, (ie rent covers mortgage & rates etc) but when you add in depreciation (which is really just a deferred cost) the property makes a loss.

[toddncar]

Thanks Keith

Once again, advice that is 'helping us see the light' in this new venture. Truely appreciate it.

[CJ]

Here is an idea with some quick numbers. I am doing the sums as I type so they may be wrong.

Sell existing house to LAQC for $440k with a new mortgage of $440k
Buy new house for personal use for $540k with a mortgage of $180k.

That way you extract the equity out and have as much "good debt" as possible.

LAQC P&L:
rent: $23,000 460x50
Interest $31,240 $440k x 7.1%
other Exp $ 3,000
Depn $ 5,000 wild guess only.

Loss $10,240
Tax refund $ 3,379 at 33% rate. will be higher if in 39% bracket
cash loss $ 6,860

Personal costs:
Interest $12,780 $180k x 7.1%
LAQC $ 6,860 To prop up for cash deficit from renting
Total cost $19,640
Per week $377

Therefore based on interest only payments, it will cost you $377 to do this compared to your current mortgage of $275 (which I assume includes some principle).

So I ask my question from above again: "Your property may make a "good rental" but does it from an investment perspective as well?"

Now for everyone to tear my numbers apart.

[Contrail]

If you can't afford much more than $550.00 a fortnight i think a 2nd mortgage is impossible regardless of what you do.

[SmallBrain]

Sell existing house to LAQC for $440k with a new mortgage of $440k
Buy new house for personal use for $540k with a mortgage of $180k.

CJ

I think the new house will need a personal mortgage of 240k.

540k - 300k (equity released by the LAQC borrowing the full 440k less the 140k still owing to the bank) = 240k

A 25yrs P&I table mortgage at 7.1% is around $395 per week. Plus around $130 per week of net cash loss from the rental (based on your calculation), that's ~$525 per week compared to the current weekly repayment of just $275, or $250 extra per week.

hmmm... sounds like a tall order for now.

[outspoken]

The first thing you need to do is phone a mortgage broker, they will be able to tell you over the phone whether your income will allow you to borrow the money in the first place. Then you will have to find a lender who will 100% finance the new property (yes you are selling it into an LAQC, but you still have to borrow 100% of the new purchase price)

Then you need to work out whether the numbers still make sense, then you need to figure out what would happen if you lost your job or got sick, then you need to ask yourself if you really want to become a part time landlord.

But first of all you should ask yourself, why are we considering this in the first place?

[JohnL]

You can always consider selling your house and buying one or two rentals with better yields (cash neutral properties are starting to come available in Auckland now).

You could also consider renting instead of buying your replacement family home in the shorter term. Some people advocate renting long term and only purchase investment properties, but that is a big decision which has emotional factors as well as the economic ones.

John

[Kerry Christian]

toddncar

Lets make it easy

Go to a professional mortgage broker - one who knows about property investment
Then go see a person who specialises in Structures
Then arrange to meet at least 3 people who have no interest in your situation but understand property and property investment

the info should be FREE - once you have done this, then u are in a position to move forward

[drelly]

Hi Toddncar,

Welcome to PT.

First things first... Why would you want to keep your existing property if it's only going to return about 5% and be a constant drain on your income at the same time you're taking on more debt?

Kerry offers good advice. However, one thing I can't stress enough is not to rely purely on the advice of others. If you don't have a good idea of why the advice is good, then you don't understand it enough to act on it. Educate yourself before taking action.