Wednesday 20 April 2022

Did a bit of refinancing

I did a bit of provisional enquiry about getting 'pre-approval' of an investment property mortgage for the off-the-plan apartment I "bought" a few years ago. Construction is due to be completed Q1 of next year, but I have seen some information indicating that it may be completed by the end of this year. Whenever it is finished a completion notice with be sent to my solicitor and I'll have only a month or two to get an inspection done (to identify and defects that need rectification) and a valuation done so I can actually apply for a mortgage.

The government tightened up the rules around 'interest only' loans and also tightened the lending criteria that lenders have to apply when evaluating investment loan applications. Based on the feedback I received I may have trouble getting a mortgage for the full amount due at settlement. There is $900K required at settlement, so if I can't get a mortgage (for at least a substantial part of that amount) I may have to liquidate some of my geared investment portfolio (which would provide around $300K net, but will incur a capital gains tax liability - so I might delay that until I know whether or not I can get a mortgage. On the other hand the Australian share market is currently at near-highs, so there is a risk of a market correction if the Ukraine war expands to involve NATO directly, so CGT might be the lesser of two evils. Hard to know). I also have another $200K available on my home equity line of credit ("portfolio loan") and DW has $450K available on her sub-account which I could draw on (and just make the interest payments). So I can fund the apartment purchase without a mortgage on the apartment, but the interest rate would be considerably higher.

Currently an investment mortgage has an interest rate of between 2% and 3% pa, depending on whether it is interest only (slightly high interest rate than on a standard P&I mortgage) and if it is variable rate, or fixed (for 1, 2, 3, or 5 years) for an initial period before reverting to the standard variable rate.

In comparison, our 'portfolio loan' has an interest rate of 4.98% (but is essentially "interest only" which means the cashflow impact won't be worse than making repayments on a P&I loan). It's not a particularly attractive interest rate, but then again our home loan interest rate is also quite high (3.61%). We'd "shop around" for a better mortgage rate and refinance the home loan, except that our outstanding home mortgage balance is quite modest (around $40K) so the interest rate doesn't have that large an impact, and because the "portfolio loan" might not be available if we pay off the home mortgage (and the bank no longer offers that sort of financing, due to the changes in government lender criteria mentioned above).

So, in case I end up having to finance the balance of the purchase price of the investment apartment using the "portfolio loan" I took up a "special offer" from Citibank to borrow up to 80% of my $60K unsecured 'line of credit' facility at an interest rate of 2.9%pa fixed for three years. At the end of that period I'll have to pay off the balance in full, or it will revert to the normal 20.49% (!) interest rate.

Despite the interest rate being 2.9%, there is also a 'minimum monthly payment' of around 1% of the balance (so I have to repay around $500/mo - mostly loan principal). It will still save me interest for the three year 'special rate' period, as I have used the balance transfer to repay some of my existing 'portfolio loan' balance, so I save the interest differential (4.98%-2.90%). Tand he interest saving is about $1,000 pa initially, but will slowly drop as the minimum payments will be funded from the 'portfolio loan' so around $6,000 pa will shift from the 2.90% rate back to the 4.98% rate each year during the three year 'balance transfer' period.

A mortgage 'pre-approval' would only be valid for three months, and I can't get an approval until the apartment valuation can occur (when construction is completed), so I won't know until the end of this year if the funding for the investment apartment will end up with an interest rate of around 2% or 5%, or somewhere in between (if I can get a small mortgage with low LVR, and fund the rest with the proceeds of my investment portfolio sale, the Citi 'balance transfer' loan, and the residual via the 'portfolio loan').

The average total return on the apartment (rental income + capital gain) should be higher than the loan interest and outgoings (strata levy, insurance etc.), but the interest rate on the loan(s) used to fund the purchase will directly impact how profitable (or how big a loss) this investment turns out to be. Every 1% change in loan interest rate will translate to $10K pa.

Of course with inflation currently running quite high, a general increase in interest rates will also have a big impact on my 'bottom line'. The exact impact is slightly complicated by the fact that the loan interest is tax deductible (via 'negative gearing'), and that the new apartment should also have a significant tax deduction from the 'depreciation schedule'. The net impact will be to reduce taxable income (taxed at my marginal tax rate) and 'convert' it into long term capital gains (which, under current tax rules, will be taxed at half my marginal tax rate).

Subscribe to Enough Wealth. Copyright 2006-2022

No comments: