Don’t listen to bad advice when you are borrowing to invest in property
It always amazes me that so many people think that borrowing to invest in property is a dumb idea, and yet they wouldn’t blink at the thought of borrowing to buy a home. When you finance a residential investment property, you are using other people’s money to make money. That’s not dumb, it’s possibly the most intelligent thing a person can do.
Sure, there’s a risk when you are borrowing to invest but is the risk greater than when borrowing to buy your own home? If you lose your tenant, your property investment could be at risk. If you lose your job, your home could be at risk. Not much difference, apart from in the case of borrowing to buy your home, if things go wrong you could be left without a roof over your head.
In this article, you’ll learn why the most common objections to borrowing to invest don’t stand up to scrutiny.
1. Borrowing to invest is too risky
OK, I’m not going to say that there is no risk when you are borrowing to invest, but the risk must be weighed up against the rewards. Risk when you are borrowing to invest increases for two reasons:
- The higher the loan-to-value, the higher the risk. If property prices fall temporarily and you need to sell, you may owe more than you can raise by selling.
- If your property remains untenanted for a long period of time, you will still have to pay the mortgage and other costs. A large negative cash flow could put pressure on your personal finances, and if you can’t afford to subsidise your monthly expenses, you could end up having the property repossessed.
How do you reduce or even eliminate these risks? Simple:
- Buy at a discount to market value, and borrow to invest 70% or less of the purchase price
The bigger the discount to market value that you can negotiate, the bigger the buffer you will have against a short-term, temporary fall in the market price of your investment property. That’s going to give you a stress-busting cushion.
In addition, the bigger the deposit you can put down, the lower your mortgage interest payments will be. And lower interest payments translate into better cash flow.
- Only buy a tenantable, ‘everyperson’ property
How do you do this? Research the location where you are considering investing. Find out who the most common tenants are (e.g. young professionals, students, young families, etc.). Make sure that the location of your investment property opportunity benefits from the strongest of property fundamentals – shops, schools, transport links, major employers and major investment.
A great property in a great location that benefits from all those fundamentals will rent.
Remember that all investment carries some risk. The key is to understand the risks and manage them. Do this, and it doesn’t matter whether it’s your money that you are investing or you are borrowing to invest. The difference is that buying with other people’s money gives you all the benefits of leveraging in property investment, and that could massively ramp up your returns.
2. You must be rich to invest in property
Another common objection, and completely wrong. In fact, some of the best and most successful property investors I’ve met didn’t have more than a few thousand in the bank. What they did have was:
- Equity they could release from their home
- The right mindset to invest
Here’s the thing: if you have equity in your home or, say, £50,000 in the bank, what good is it doing you? With inflation at 3% and savings rates at near zero, the value of your cash saving is eroding every day.
Instead, wouldn’t it be better to use some of your savings or home equity as a deposit on an investment property? You might achieve rental income of 5% to 10% – and not just on your deposit, but on the money you are borrowing to invest, too! Then, of course, there’s the potential for capital gain should the value of the property increase. How much could an investment property make you? Read our article “Property investors in the UK achieve ROIs of up to 20% in 2017” to get an idea of how those profits could stack up.
You don’t have to be rich to invest in property, but investing in property could make you rich.
3. Negative cash flow properties are money pits
For many property investors, the ideal is to buy a property that produces positive cash flow immediately. This covers all your costs and pays you a passive income. Many beginner investors think that negative cash flow properties lose you money. Not necessarily true.
Often, a negative cash flow property will provide a better capital gain than a positive cash flow property. If you need to pay, say, £100 per month to subsidise the costs of holding the property and it increases in value by £800 per month… well, I don’t need to explain why this would be a good deal.
Also, cash flow on investment property increases over time. Rents rise, and the effect of the mortgage payment decreases. If you had bought a buy-to-let investment property in 2000 and paid £70,000 with a mortgage of £50,000, your rental income of £3,500 would have struggled to cover your mortgage interest of £2,500 and other costs. Today, the rental income has increased to £10,000, while the mortgage interest payments remain at £2,500.
4. You’ll pay tax on your mortgage payments
It’s true that the tax advantages of borrowing to invest are being eroded over the next three years, but it is higher rate taxpayers who are affected. This is because the tax relief is being limited to basic rate tax. But you can still claim relief at the basic rate of tax, regardless of being a higher rate taxpayer.
In addition, there are also strategies to maximise buy-to-let rental yield and minimise tax. Your challenge is to decide which is the best tax strategy to combine with your investment strategy to achieve your goals.
The very best property investors borrowing money to invest. Want to know why, and how to work out the right level of leverage to meet your investment goals? Get in touch with Gladfish on +44 207 923 6100. We help investors achieve the best price, on the best property, in the best location, with the best financing decisions.
Live with passion
Brett Alegre-Wood
