Join Australia's most dynamic and respected property investment community

How I've utilised Cashbonds for Increasing Serviceability

Discussion in 'Innovative Techniques' started by Rixter, 9th Feb, 2016.

  1. Rixter

    Rixter Well-Known Member

    Joined:
    18th Jun, 2015
    Posts:
    572
    Location:
    Portfolio Perth Brisbane Sydney Melbourne
    I've been getting people contacting me asking about how I have used Cashbonds/Annuities to increase serviceability....

    When one has a few IP's under their belts the issue of serviceability will eventually rear its ugly head. The banks/non-banks start balking to lend out borrowed funds due to one not meeting their lending criteria. As you know banks/non-banks determine serviceability under 2 modules - LVR & DSR.

    Where the majority of investors start reaching their borrowing capacities is in relation to DSR. In other words, insufficient income to service one's debt levels. Now this doesn't become a problem if one can increase their income, so how can that be done....

    There are many ways - however the main way most investors know is to increase one's PAYG income and/or increase their rental income. As these methods are fairly reliant upon / restricted to market conditions the majority of investors become stuck on where to go to from there. Most overlook the store of equity they may have available from low LVR's created over time due to past capital growth.

    That's where I've utilised a Cashbond or Annuity stucture into play, to work around potential serviceability issues and to allow me to keep accessing finance in the property acquisition phase of our portfolio.

    A cashbond works by converting existing portfolio equity into cash flow for the purposes of increasing one's income in the eyes of the banks/non-bank lenders.

    The basic way it works is as follows - one purchases a Cashbond/Annuity or guaranteed income plan from an insurance company or bank. I use Challenger Life, a life insurance company. The annuity income plan is then paid back, either monthly, quarterly, 6 monthly or annually over a nominated term. These terms can range from one year to 50 years.

    Which term best suits depends upon a number of factors such as one's equity level availability, one's annual income increase required, and the minimum term requirements of one's banks/non bank lender. I use 5 years with annuities purchased with funds from offset accounts and LOC's.

    Purely as an example, if one purchased a $100k cashbond with a 5 year term maturity, each year one would received around $20,000 plus interest paid back. Now when one goes to a bank/ non-bank lender to loan funds for their next property purchase, 100% of the extra annual income can be shown on the INCOMES side of the loan application cumulative to one's existing PAYG Income & rental income...You have effectively increased your borrowing capacity from the annuity income, in the eyes of the bank/lender.

    If LOC funding is used to purchase the annuity, one is effectively purchasing an income stream and therefore it comes at a price. That price is brought about by the interest rate differential between LOC & annuity rate earned. IMO one should examine their own personal situation before deciding whether its a viable option for them only after having explored and/or exhausted all other less impacting options available.

    This how I have been able to keep borrowing for income producing and lifestyle purposes. Now I know this type of financial structure is not for everyone. It's an advanced strategy for experienced investors with substantial equity holdings contained within their portfolio - all based around one's big picture investment strategy, goals, time frames & individual investor risk profile.

    Being able to build a substantial size residential property portfolio is NOT about 'property'.

    Its about finance and structuring it in such a way so as to be in a position of being able to continually accessing it to keep purchasing and building your portfolio further.

    You must meet the banks/lender LVR & DSR lending modules and continually place yourself in a position to do so 'before' hitting their module walls because if you leave it until after its too late - catch 22.

    Hope this provides some food for thought.
     
    GOU, Xenia, House and 9 others like this.
  2. Tim & Chrissy

    Tim & Chrissy Well-Known Member

    Joined:
    5th Dec, 2015
    Posts:
    813
    Location:
    NSW
    We are at our serviceability limit, going through valuation/approval with a non APRA lender now. We still have a lot of equity available.

    Could this strategy work in that situation?
     
    Last edited: 9th Feb, 2016
  3. wealth

    wealth New Member

    Joined:
    6th Jul, 2015
    Posts:
    3
    Location:
    WA
    Thanks for the info. Very useful to know.
     
  4. Biz

    Biz Well-Known Member

    Joined:
    18th Jun, 2015
    Posts:
    1,473
    Location:
    Sydney
  5. Perthguy

    Perthguy Well-Known Member

    Joined:
    23rd Jun, 2015
    Posts:
    4,696
    Location:
    Perth
    Thanks for posting @Rixter. I am interested in this for my investment partner. He is an equity rich low income earner, so serviceability is an ongoing issue.

    Having a look at the Term Annuity options, there are two options: 'Capital returned at end' and 'Capital returned throughout'. Are you using the 'Capital returned throughout option'?

    Using the example of $300,000, the 'Capital returned at end' option would boost his income by $9,750 per year. This doesn't appear to be particularly useful?

    The 'Capital returned throughout' option would boost his income by $55,470 which appears to be more useful. However, would he be required to pay tax on the $55,470?
     
    SirDingo likes this.
  6. D.T.

    D.T. Adelaide Property Manager Business Member

    Joined:
    13th Jun, 2015
    Posts:
    5,583
    Location:
    Adelaide, SA
    It's essentially the same as a P&I loan being paid back to you, so yes pay tax on the interest component but not the principle component. Similarly the interest on the loan you bought the instrument with should be deductible.

    Before investing such a big chunk of equity, double check with brokers which lenders will accept this in their calcs. From memory they wanted you to be a year or 2 into it, like with share dividends.

    This is a copy and paste from 10 years ago and the lending environment has changed a lot.
     
    Last edited: 10th Feb, 2016
    Perthguy and pinkboy like this.
  7. Perthguy

    Perthguy Well-Known Member

    Joined:
    23rd Jun, 2015
    Posts:
    4,696
    Location:
    Perth
    Thanks @D.T. and I agree. I would not advise that he do this, just presenting it as an option with a lot of due diligence to follow if he decides to pursue it. Definitely need to sit down with the mortgage broker to map out a strategy and see if this might help. There's definitely a lot more work to be done before he can make a decision. Besides talking to the broker to find out if this will even help, he is going to need tax advice and also weigh up the opportunity cost of having those funds tied up for 5 years. I don't think it is a very easy decision and I think it really depends on what his goals are and how he wants to get there.
     
  8. S0805

    S0805 Well-Known Member

    Joined:
    3rd Jul, 2015
    Posts:
    333
    Location:
    VIC
    Rixter, Just so I understand this equity built in your properties (e.g. IP, PPOR) is being used for annuities in your case OR are these your genuine savings staked in offset account???

    E.G. if you have 50K equity available in one of your IP, are you releasing this as separate split and then investing in annuities? In this case the tax will be deductible (i think as its for income purposes) but your debt increase at the same time. OR Are you just using 50K cash savings currently parked in your offset in annuities?
     
  9. Rixter

    Rixter Well-Known Member

    Joined:
    18th Jun, 2015
    Posts:
    572
    Location:
    Portfolio Perth Brisbane Sydney Melbourne
    @Tim & Chrissy As noted earlier, this is an advanced type strategy, more suited for experienced investors who have accumulated a multitude of property purchased for CG and who have substantial equity holdings within their portfolio's. As such, the equity burned if purchasing via LOC is probably only going to be a fraction of what they have at their disposals.

    Someone who has 2-3 IPs with a modest amount of equity probably isn't going to have sufficient funds to purchase the annuity, have surplus for IP deposits and place themselves in a position to mitigate risks all at the same time.

    If someone finds them self in a situation where they require a CB it maybe too late to structure one then anyway.. they have probably already painted themselves into the corner and the damage it done. They need to have the foresight to have already placed them selves in position to have the CB already structured prior to their hitting DSR ceiling.

    A CB structure is not a lone strategy to be deployed by it self - a CB structure is just one element that is utilised in a larger property investment strategy.

    @Perthguy There are 2 types of Annuity - RCV0 & RCV100. It stands for Residual Capital Value 0 & Residual Capital Value 100.

    In relation to RCV100 one still has their initial capital left upon their CB term maturity date.

    With RCV0 one has their initial CB purchase capital, plus interest, returned to them. As such, upon CB term maturity date all funds have been exhausted.

    The type of Annuity that needs to be selected for our purpose here is RCV0. It pays back capital and income over the period, and is all deemed as "income".

    As previously mentioned, the whole purpose for utilising a CB in the first instance is to increase serviceability in the eyes of the bank/lenders. Therefore in order to maximise one's borrowing capacity it's mandatory one chooses the capital returned throughout CB term option, in order to demonstrate to the bank/lender the maximum level of income possible.

    The CB 'interest component' earned would be declared within one's gross annual income, not the full $55470 as per your example.

    @S0805 I have utlised the CB structure numerously for the past 11 years. This includes pre & post GFC and in recent times, the year immediately prior to rat race exit/retirement, as well as post APRA initiatives for the current project build. Over that time I have used a mix of Investment LOC's alone up until just prior to rat race exit where a complete restructure of finances was required to facilitate retirement/financial independence. As such I now use a mix of both investment & personal LOCs & offset saving accounts.

    If purchasing using LOC's, there will be small residual Cashflow loss due to the difference between LOC interest payable & CB income return, that maybe tax deductible depending upon one's circumstances & how they're financial structured. If using savings the residual is negated.

    Through out the portfolio acquisition phase over the years I have used numerous mortgage brokers/financial strategist for financial structuring. Now days, post financial independence, dealings are carried out direct with our bank/lenders.

    I hope this helps.
     
    Last edited: 11th Feb, 2016
    Cactus, ellejay, Elives and 1 other person like this.
  10. Wukong

    Wukong Well-Known Member

    Joined:
    18th Jun, 2015
    Posts:
    214
    Location:
    NSW
    @Rixter How do you define modest and substantial equity?
     
    Elives likes this.
  11. Tim & Chrissy

    Tim & Chrissy Well-Known Member

    Joined:
    5th Dec, 2015
    Posts:
    813
    Location:
    NSW
    We have substantial equity, just no serviceability unfortunately. How long does it take for annuities to be considered
     
    Perthguy likes this.
  12. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,975
    Location:
    Sydney
    About an hour.

    Keep in mind that these are financial products and brokers cannot advise on taking them out but they can advise on whether the income from an annuity could be taken into account as income for servicing purposes.

    There are also issues with brokers and the NCCP. By using this strategy is a broker helping someone take a loan out that they cannot afford?
     
    Rixter likes this.
  13. MTR

    MTR Well-Known Member Premium Member

    Joined:
    19th Jun, 2015
    Posts:
    7,389
    Location:
    Perth, Melbourne, USA
    You could also look at lo doc products such as RAMS, you will require an accountant signing off on your income.

    RAMS is very good around 5%, minimal fees.

    MTR:)
     
  14. S0805

    S0805 Well-Known Member

    Joined:
    3rd Jul, 2015
    Posts:
    333
    Location:
    VIC
    @Rixter I am not sure if I understand your reply. As part of this strategy we want annuities income to be included in file for lender to consider. So you have 100K LOC setup, don't lender consider this as 100K in debt cause you can use it any time?

    Assume if they don't consider 100K LOC as debt & let's say you use 50K of this LOC and put in annuities basically you've increased your debt by 50K and created income stream for you. In this case when lender consider yours annuities income they will also include 50K in debt column as well....Am i missing something?

    I can understand if above strategy to be used from your genuine savings then you are converting your savings into income stream which lender can consider. My understanding is lender don't consider your savings for serviceability...
     
  15. Tim & Chrissy

    Tim & Chrissy Well-Known Member

    Joined:
    5th Dec, 2015
    Posts:
    813
    Location:
    NSW
    RAMS will probably be our next move, or another lender who is more favourable for self employed.
     
  16. Tim & Chrissy

    Tim & Chrissy Well-Known Member

    Joined:
    5th Dec, 2015
    Posts:
    813
    Location:
    NSW
    I would be looking at this as more of an option for extending serviceability down the track. So if I can lay the ground work with annuities now to benefit in 2 - 3 years time that'd be fine.

    I'll re-phrase the time question, how long do we need to hold a annuity for a lender to include it in servicing?

    They are a completely new concept to me, I still don't understand how it works.
     
    Perthguy likes this.
  17. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,975
    Location:
    Sydney
    I am not sure it matters how long you have held it for.
     
  18. Tim & Chrissy

    Tim & Chrissy Well-Known Member

    Joined:
    5th Dec, 2015
    Posts:
    813
    Location:
    NSW
    Okay, so what is the issue with reaching max serviceability and then investing in annuities? Rixter says it's too late by that stage?
     
  19. D.T.

    D.T. Adelaide Property Manager Business Member

    Joined:
    13th Jun, 2015
    Posts:
    5,583
    Location:
    Adelaide, SA
    Because you're investing in them using equity in the property - you can't release equity if you have no serviceability left.
     
  20. Tim & Chrissy

    Tim & Chrissy Well-Known Member

    Joined:
    5th Dec, 2015
    Posts:
    813
    Location:
    NSW
    Okay so you draw equity via a home loan to purchase a annuities?

    I'm looking up the ' for dummies' website now and reading up on them :p