Loan structure 101: How to finance a property portfolio

loan structure

Borrowing to invest in property is a popular and highly effective wealth accumulation strategy if it’s implemented correctly. However, loan structuring can often be an afterthought. The reality is that loan structuring and maximising your borrowing capacity is almost just as important as buying the right property. This blog sets out how to structure your loans to build a property portfolio.

A step-by-step example

The video below takes you through an example of how to structure your loans.

Step one: access equity (deposit loan)

You will need to pay a deposit (usually 10%) when you purchase a property. Therefore, you need to arrange access to these borrowed funds. Even if you have access to cash savings, I still recommend that you establish a new loan. This blog explains why this is important.

I recommend arranging a loan sufficient to fund 20% of the property’s value plus all costs in addition to a buffer. This loan will be secured by an existing property e.g. your home.

Step two: arrange an 80% loan

You will be able to fund 20% plus all costs from the deposit loan. Therefore, you need to arrange a second investment loan to fund the remaining 80%. This loan will be secured by the investment property only. This loan should be pre-approved before you purchase.

Step three: consolidate loans

When your investment property’s value has risen by 35% to 40% above the purchase price, which could take 5 to 7 years, you should be able to consolidate the deposit loan with the 80% loan so that all the debt is in one loan solely secured by the investment property. In this case, your home is no longer required as security.

This structure avoids cross-securitisation which is important as explained in this blog.

Additional investment properties

If you plan to invest in multiple properties, you can repeat the steps above. For simplicity, it is acceptable to maintain one deposit loan to fund deposits for multiple properties. If you do so, you must maintain good record keeping. Personally, I maintain a spreadsheet that includes a list of all purchasing costs, as that helps me verify loan amounts and calculates the investment property’s cost base for CGT purposes.

Current considerations

The table below sets out how we generally structure interest rates and repayments in the current environment. Of course, if you are reading this blog after 2021, these recommendations may no longer be appropriate.

loan structure

Successful investors don’t care about interest rates

Borrowing costs (interest rates and fees) are important, of course. However, maximising your borrowing capacity in a safe and prudent manner is far more important… about 8.5 times more important to be specific!

There are two important benefits resulting from having a higher borrowing capacity. Firstly, you will be able to afford to invest in a higher-quality asset. Higher quality assets generally exhibit higher long-term capital growth rates and lower investment risks. Secondly, it may help you invest in more assets i.e. buy another investment property.  

I would rather pay a higher interest rate if it allowed me to invest in a better-quality asset. For example, paying 0.50% p.a. in additional interest on $1 million loan will cost you less than $53,000 after tax over the next 20 years in today’s dollars. But a 1% higher capital growth rate will make your approximately $450,000 more in equity after tax (CGT). That equates to an 8.5 times return on your investment! That is why maximining your borrowing capacity is far more important than minimising your interest rate. Of course, it is a great outcome if you can optimise both, but never, ever compromise on borrowing capacity.

You should expect to refinance every 2 to 5 years

Refinancing loans is an administrative pain. Anyone that has set up a new loan over the past few years can attest to that. The amount of information you need to provide to the banks (often multiple times) and the number of forms that need to be completed is staggering. But the reality is that lenders (banks) change lending appetite and credit policies almost as often as the wind changes. Therefore, whilst your existing lender/s might be suitable for you today, there is no guarantee they will be in 3 years from now, for example. In fact, there’s a good chance they won’t be. Successful investors know that finance is a game and you’ve got to be willing to play that game. That includes switching to a new lender when necessary. Avoiding a refinance is easier. But sometimes the easiest path is not the most effective.

An experienced mortgage broker is vital 

An experience mortgage broker will be able to help you structure your loans to ensure you maximise any tax benefits as well as your borrowing capacity. The benefits that an experienced mortgage broker can/should provide you, in addition to loan structuring, include:

  • Knowledge and experience. The lending industry is a very dynamic marketplace. Things are changing all the time; credit policy, interest rates, laws, regulations, credit appetite and the list goes on. You need an experienced broker to help you navigate these risks and opportunities. Someone that goes into bat for you. That represents your best interest.
  • Whilst loan applications are neither enjoyable or instantaneous, a professional mortgage broker will save you a lot of time through completing forms, answering inevitable (and often banal) questions from the lender, following up matters to avoid delays, liaising with other providers such as your accountant and lawyers and so on.
  • Proactively re-pricing loans. This chart from the RBA clearly shows that existing borrowers are paying higher interest rates than new borrowers. That’s because higher discounts are typically offered by the banks to attract new business. Therefore, it is important to periodically re-price loans to ensure you are receiving the highest interest rate discount possible. My firm is currently implementing a technology tool that uses an algorithm to trawl over our client’s loans and automatically apply for higher discounts when they become available. It automates the whole process, so our clients don’t need to do anything.

Building wealth is a game of finance, not property

Investor and educator, Michael Yardney says “property investment is a game of finance with some houses thrown in the middle”, and I couldn’t agree more. To master any game, you must learn the rules. And if you would like to do that, I suggest you grab a copy of my book, Rules of the Lending Game. For a limited time, you can buy a copy of this book for only $20 (free postage) if you use the code BLOG. Books are mailed by Australia Post so please allow 1 – 2 weeks for delivery.