Originally posted by GlennM
(i) If a property has gained $70,000 from a 5% increase over 3 years ($450,000 to $520,000), then you said you have $70,000 to use to borrow for your next property.......however, a bank will normally only lend (80% of $520,000 = $416,000 less what you owe of $450,000)....and hence nothing to draw down on? In order to draw down on $70,000, the value of the property would need to be $650,000!!!
Glenn:
(i) If you bought a property for $450K, it would have been subject to an LVR also, meaning the original loan would only have been $405K (90%) for example. An amount of $45-90K had to come from somewhere else, forming the deposit. That would likely have been funded from another property (eg. PPOR). So when the property grows by $70K to $520K, you can increase your LOC to 0.8*520K = $416K, which is $56K above the original $360K. Steve is incorrect to say (sorry, Steve) that the entire $70K of growth is available - only 80% of it is available ($70K * 0.8 = 56K).
Steve says:
1) You might be asking what happens at the end of the three years, when you have spent the money?? Well $2,200,000 of property growing at 5% pa = $110,000, which is MORE than you are spending each year <snip>.
I believe Steve is also slightly wrong here, because your 5% growth on $2,200,000 of property is certainly $110,000, but once again only 80% will be accessible to maintain reasonable LVR = $88,000 per annum (ie. for the next 3 year cashbond). (Actually, when you compound the growth of 5% over 3 years you get total growth of $346,775).
So, you have total growth of $346,775 for the next 3 years (the 3 years you are living on your original Cash Bond). You go back to the bank to top-up your LOC and they will only lend you 80% of that, meaning your LOC only increases by $277,420 this time.
The $277,420 can then be used to buy another Cash Bond for 3 years, but obviously this time it won't provide $125,000 per annum, more like $92473 per annum.
Of course, you have also borrowed another $346,775 (in your LOC) and interest on that comes to $22,540 per annum @ 6.5%, meaning your accessible income is now down to $92473-$22540 = $69,933.
Clearly what is happening here is that your income is dropping because your assets are not delivering sufficient growth. To keep a sustainable income, you would have to probably accept [roughly] a $70,000 per annum nett income instead of a $100,000 per annum income.
My logic is that you have $2,200,000 of property, your original 90% loans were $1,389,600. You acquire a LOC at 80% LVR = $1,760,000 which gives you another $370,000 on top of your original IO loans of $1,389,600. Just because you have $369,000 LOC doesn't mean you can actually use [all of] it. The most I think you can really use to buy a cashbond is roughly based on 80% of 5% of $2,200,000 per annum, or $88,000 per annum. If you buy a cash bond for more than this, your capital growth (at 5%), reduced to 80% for LVR reasons, won't be able to buy another cash bond of the same amount. So, even though you have $370,000 available in a LOC, I'd figure you'd only spend $88,000*3=$264,000 on a cashbond.
The borrowing costs for a $264,000 cashbond would be $17,160 per annum, so your $88,000 income from the cashbond would leave you $70,840 nett income.
In 3 years time, your $2,200,000 has grown to $2,546,775, a capital growth of $346,775 (as noted previously). You can now increase your LOC to $2,037,420, which is $277,427 more. You didn't use your full LOC last time (in fact, your LOC balance = $1,389,600 + $264,000 = $1,653,600), so now you have access to $383,320. But, once again, you really only want to purchase a cashbond no more than the capital growth you expect to receive, or $101,871 per annum, or a $306,000 (approx) cash bond.
The borrowing costs for a $306,000 cash bond would be $19,890, so your nett income would be $101,871-$19,890 = $81,981.
By not sacrificing the capital "too early" you now have an income which continues to grow rather than shrinking.
Now it's time for some of my questions (and my assumptions):
1. After 3 years (when the first cash bond "runs out"), you still owe the bank $369,000 (or $264,000 per my example). It has not been paid out anywhere. What funds the continued interest payments on this amount? I presume the rental income from the properties commensurately grows so it is cashflow neutral and therefore covers the growing interest bill.
2. After 3 years (after purchasing the cash bond), you now have $369,000 (or $264,000) LOC amount that was used to fund your "personal lifestyle" (ie. providing your income).
Surely this amount cannot be tax deductible any longer against the property?
If so, are you not essentially creating non-deductible debt for yourself? The original amount of deductible debt of $1,389,600 remains. You now have $369,000 or $264,000 of "personal debt"?
What that implies to me is that your $2,200,000 of property, with only $1,389,600 of deductible debt, is very very likely to be cashflow positive, and you will pay tax on that positive cashflow,
and then you must use the balance to fund the interest bill on the deductible debt?