The power of leverage
The great benefit of investing in residential property is the ability to use it as leverage to purchase further assets that increase your equity and/or income. Lenders prefer to take residential property as security because of its stability relative to other asset classes such as shares. As a result, residential property provides a higher degree of leverage – usually 80% of the property’s value without mortgage insurance; higher with mortgage insurance. This enables you to purchase assets that you may not otherwise be able to afford. It also maximises the return on your capital.
As you can see in the below, if you contribute the same amount of cash, purchase at a higher purchase price (as long as it is affordable) and obtain a combined return that is greater than the interest cost, your overall return increases.
|Investor 1||Investor 2||Investor 3|
|Interest paid @ 5% p.a.||$36,000||$26,000||$16,000|
|Rent received @ 3% p.a.||$24,000||$18,000||$12,000|
|Growth @ 5% p.a.||$40,000||$30,000||$20,000|
|Return on capital||35%||28%||20%|
Table – Leverage and return on capital
* Return on capital = Net gain (capital growth + rent – interest paid)/capital invested
Should you be in a position to have an extra $50 per week working for you, because your loan structure is set up effectively, below is an example of how you can save an extra $135,000 on a loan of $200,000 the life of the loan. This is almost 70% of the original amount borrowed. These extra savings might come from optimal use of offset accounts, maximising deductions, asset and income growth from being able to hold properties or simply minimising buying and selling costs.
If you can get all aspects of your Mortgage Strategy working for you during your lifetime you will set the foundation for a strong financial and property future, enabling you to live your ideal lifestyle. This highlights the power of compounding through an effective Mortgage Strategy.
Table– Power of an effective mortgage strategyIf you plan to or would like to strive to hold your first purchase long term, there are mortgage strategies that we should implement to optimise your likelihood to be able to achieve this outcome. You have one opportunity to maximise your deductions through your loan structure – at the time of purchasing the asset. If you miss this opportunity, it can be very costly in the long term and any mistake cannot be reversed due to the Purpose Test. Any mistakes with your mortgage strategy will incur a lifetime of opportunity cost missed due to the period the finances were poorly structured.
David is the Founder and Managing Director of Property Planning Australia, author of ‘How to Succeed with Property to Create your Ideal Lifestyle’, co-author of ‘Property for Life – Using Property to Plan Your Financial Future’, co-host of the ‘Property Planner, Buyer and Professor Podcast’ and a widely-published media commentator. With more than 20 years of experience, David is passionate about educating others to make informed, and ultimately, more lucrative property investment decisions. David established Property Planning Australia in 2004 – with the vision to educate and empower Australians to make successful property, mortgage strategy and money management decisions. Property Planning Australia’s operations have earned acclaim and national industry awards for its unique fusion of property planning, education, money management, mortgage strategy and risk management. All supported by multi award-winning customer service.