With the Global Financial Crisis and interest rates falling to all time low for many countries all over the world it is obvious that certain investments that were not viable during a high interest environment is now possible with cost of funding (i.e. interest rates halving or more)

With low interest rates many people are also opting for variable loans instead of fixed loans, especially since fixed rates are sometimes quite a bit more higher than the variable rates. The combination of low interest rates and investors taking advantage of the low interest environment can lead to a financial disaster if not planned properly…

Why you might ask? well it’s very simple, if interest rates increase the repayment amount would obviously increase except it will hurt the investor a lot more at low interest rates (lower base).

For example,

• When interest rates were around 7% and interest rates increased by 0.5% to 7.5%, the investor would have to pay 7.143% (7.5%/7%) more in interest expense.
• However if interest rates are around 4% and interest rates increased by 0.5% to 4.5%, the investor would have to pay 12.5% (4.5%/4%) more in interest expense!

Hopefully you can see that it’s over 3 times (12.5%/7.143%) the increase in interest expense!

Currently, Australia’s cash rate is 3% with the cash rate traditionally being around 5-6% it would not be a surprise if the cash rate increase over the next few years back to the average of around 5-6% (i.e doubling in interest rates, meaning doubling in interest repayments!)

Graph Courtesy of Forex Blog

So don’t fall for the interest rate trap! Think about the potential increase in interest rates before making any investments especially if you are not able to financially sustain future interest rate rises!

Residential Property Investment – Barriers > What if Interest Rates Goes Up?

Okay, Here’s the first one of the fears!
What if Interest Rates Goes Up?

If you are scared of interest rates going up then the solution is to fix it. Just remember that interest rates can both go up and down. Fixing the interest rate reduces the risk that you will have to pay more interest in the future (i.e. guarantee that your interest expense is constant over the period) However, if interest rate drops and you have fixed it then you won’t get any benefit of the interest savings. A suggestion is to fix half the loan so that you can get 1/2 the benefit of interest movement in either direction.

Most people think are scared that interest rates, fixing interest rates will only guarantee that your expense is known (ie. it will not increase or decrease). The factor to note when fixing your interest rates, especially in the more recent economic time (2008) when interest rates all over the world has dropped dramatically, is that fixed rate break cost will go up approximately proportional to the interest savings from the rate drop.

Remember that Banks lend money based on your current financial situation, so as the financial situation improves (e.g. interest rate drop) you would benefit, however if the financial situation deteriorate (e.g. interest rate rise) you would suffer. That is why some people prefer the certainty of being able to service the interest payments through good times or bad times (assuming their financial situation does not change through time)

So think about this the next time you think about fixing your interest rates!

Residential Property Investment – Barriers > What if Interest Rates Goes Up?

Residential Property Investment – Barriers > What if My Property Gets Destroyed by My Tenant?

I find it very funny when I hear people asking, “what if my property gets destroyed by my tenant?”. What’s even more funny is when its on current affairs and you see the property with holes in walls, missing doors and windows etc. The only reason why a person would worry or have troubles sleeping at night is if they don’t have the appropriate insurance or are under insured (if you can’t get a good night sleep because of your investment properties, buying the right type and amount of insurance may solve your problems) If one of my investment property were damaged I wouldn’t be sad, I would be happy I get something repaired and replace (which might also lead to increase depreciation)

There are two main types of insurance with residential property investment

• Landlord Insurance
• Rental Cover / Rental Protection Insurance

Landlord insurance covers the building, is exactly the same as building insurance in a normal house that you live in except it covers you when your tenant damages your property. Landlord insurance cost about the same as a normal house insurance (so it depends on the value insured)

Rental Cover/Rental Protection Insurance covers you for:

• Loss of Rent
• Damage & Theft (building)
• Damage & Theft (contents)
• Legal Costs
• Legal Liability

Sometimes I think people don’t know that both landlord insurance and rental cover/rental protection are not expensive (no more than 1-2 weeks rent). Remember that residential property investment is a business, you would think that most business owners will buy the appropriate insurance to cover themselves, and I suggest you do so to!

Remember, most people would never drive a brand new car out of the dealership without buying car insurance. Why would you not buy landlord insurance and rental cover/rental protection? Your car is guaranteed to depreciate in time, whereas your investment property has a much higher chance of appreciating through time.

So to answer the question, “What if My Property Gets Destroyed by My Tenant?”
Answer: Call your insurance company and let them know what has happened and they will sort you out. If you don’t have insurance, go buy some! More importantly, make sure you insure your investment properties for the right amount with the appropriate cover.

True story: an investor friend of mine recently had one of their investment property maliciously damaged by their tenant (the burnt his property down). Because he was well insured with both landlord and rental insurance he was paid the rebuild value and loss of rent as the property was not leasable for obvious reasons. He was pretty happy with the final result because it allowed him to subdivide and build two properties on his land (one of the house was free because of the insurance payout – talk about buy one get one free)

Residential Property Investment – Barriers > What if My Property Gets Destroyed by My Tenant?

Residential Property Investment – Barriers > What if Interest Rates Goes Up?

Okay, Here’s the first one of the fears!
What if Interest Rates Goes Up?

If you are scared of interest rates going up then the solution is to fix it. Just remember that interest rates can both go up and down. Fixing the interest rate reduces 1/2 your risk (ie. it reduces the risk that you will have to pay more interest in the future) and guarantee that your interest expense is constant over the period. Obviously if interest rate drops and you fixed it then you won’t get any benefit of the interest savings. A suggestion is to fix half the loan so that you can get 1/2 the benefit of interest movement in either direction.

Most people think are scared that interest rates, fixing interest rates will only guarantee that your expense is known (ie. it will not increase or decrease). The factor to note when fixing your interest rates, especially in the more recent economic time (2008) when interest rates all over the world has dropped dramatically, is that fixed rate break cost will go up approximately proportional to the interest savings from the rate drop.

Example:
Loan Amount: $300,000
Fixed Interest Rate: 8%
Fixed Term: 2 years
Current Interest Payable: $24,000

If interest rates dropped 2% from 8% to 6%, a person on variable loan would save $6,000 (2% x $300,000) in interest payments (ie. instead of paying $24,000, they would now pay $18,000 @ 6%)

If you were to break your fixed rate loan with 2 years remaining, a fee of approximately $6,000 x 2 years = $12,000 would be charged to break out of the fixed rate loan. This would effectively make breaking your fixed rate loan not worthwhile. (Note: the actual break fee depends on the prevailing cost of funding for the bank and not the interest rate that is advertised on the loan, though it is a good approximation)

The upside here is that when the bank gave you the loan at 8% you were able to service the debt and if your financial circumstances hasn’t changed, then you would still able to service the debt without. Personally, the large interest rate drops have affected my fixed loans and there is not much I can do about it. That said, if I had a choice to rewind time, I would have fixed my loans. Personally I prefer the certainty of knowing that my expenses are fixed than hoping for a chance of interest rate drops.

Here’s a link to some resources on Real Estate

Residential Property Investment – Barriers > What if Interest Rates Goes Up?

Here are some of the most common questions people ask me when they are thinking about residential property investment. It’s always the same questions every time, so I’ll be linking up this page over the next few weeks with the answers and also adding extra things when I think of it. Hopefully this will help you take the next step or ideas to increase your sleep at night factor.

It makes sense to ask these questions, in residential property investment there are very limited areas to actually worry about. It’s either something to do with the income (ie. rental) or the expense (ie. interest expense)

Here the usual suspect:

• Expense: What if interest rates goes up?
• Income: What if my property gets destroyed by my tenant?
• Income: What if my tenant does not pay or leaves before the lease is finished?
• Expense: What if the insurance company does not pay when I make a claim?
• Expense: What if the insurance company does not want to insure me?
• Expense: What if my property burns down?