Lmi or No LMI case studies

Wondering if anyone has done any calcs on the benefits of going 80% lvr vs say below 90% lvr and using lmi to save deposit (stash in offset) to enable faster purchases of properties given you'll have a deposit down faster.

Assuming your purchasing via say a construction loan(FHBs) your first few years from settlement could potentially be constructiom and therefore LMI would be capitalised and not deductible until you can convert to a rental... So tax benefits of the last two or three years lmi being deductible seems insignificant.

A lmi of say circa 5.5k on your standard 450k loan or thereabouts assuming an 88% lvr would mean roughly 40k in deposit saved (by payinf the 5k lmi) over an 80% lvr.

Thoughts? Would anyone still use lmi given current finance and property landscape.... (not that great)

 

For purchases - absolutely.

If you're wanting to take an aggressive approach - then continue to utilise LMI. Just don't expect to release equity at 90% - that's becoming increasingly difficult. Therefore - best to purchase around the 90% mark rather than 80% and trying to top up later.

Cheers

Jamie

 

By purchases i assume you're referring to existing stock, or do you still believe the same applies to constructible loan situations?

Agreed, but sweet spot would be 88% plus capitalised lmi wouldn't it as i note it jumps quite abit at 89,90.

 

If I wanted to take an aggressive approach to property accumulation - then yes, I'd still leverage LMI if the property was being built (doesn't really make a difference if it's new or established)

 

Main difference would probably be non deductibility of lmi during construction phase. Vs an outright purchase and getting it onto rental market immediately.

I know they say you can add it to cost bases but assuming you follow the half of the room that advocates never selling and paying tax and other costs, and just drawing equity to expand, then you'd never see this capitalised lmi returned

 

If intending to construct (and keep) a rental property, I'd argue it's deductible.

 

It's all about resources. It's great if you don't have to pay LMI. Cheaper rates, easier loan approvals and you're not flushing an LMI premium down the toilet!

The reality is though, that many people don't have the resources to find that extra 10% given how quickly they want to accumulate. When many people start investing, deposits are often the limiting factor in how far they can go in the immediate future, so they pay the LMI and borrow 90% to build a portfolio faster.

Years later, deposits become less of a concern. Equity has a way of building up on you by stealth if you're not watching it. One day you wake up and finding the equity for a deposit is pretty easy. At this point it's usually the affordability that's often putting the breaks on. This is where 20% deposits are useful as the rules are a little more relaxed and can sometimes be bent.

As a result, quite a few people start with paying LMI to get a larger footprint sooner.

 

DT agreed but the complicating factor would be the FHB grants. Your intention would be a ppor, at which point after 6 months you'd be back to renting it out. So the waters are murky and id say your intention would be for ppor if you want to meet fhb eligibility... Unfortunately making that construction through to rental period being non deductible..

Peter good point. But arguably if one could afford a 20% deposit now and still make up another 10% deposit before the next property in the next year or two would you still argue it'd be best to preserve deposits for future purchases as a fall back for the current unknown?

Would anyone argue the chances are of tighter investment lending and lvr requirements by banks in years ahead, therefore use lmi as much as you can up to that 88% sweet spot.....?

 

I'm not sure the regulator impact should sway decision making so much. The choice to use LMI is suited for investment strategies that require the preservation of capital (aggressive strategies). If you've got ample cash and want 1-2 properties, by all means an 80% play is suitable. Thats usually for investors who have serious equity built up over an extended period. For those that are limited by deposits/equity, often access to your own cash, whether its used for more aggressive investing or not, can be a very useful risk management technique too.

In terms of future regulatory changes, its quite unlikely that the regulator will put a stop on higher LVR loans - the rise of these type of loans through the boom has been marginal and isn't really a priority area of concern for Australian regulators.

Cheers,
Redom

 

My 'rule of thumb' says,
1. You can buy 3 IPs with 88% LVR instead of 2 IPs with 80% LVR.
2. It takes about 12 years to recover the whole LMI cost through negative gearing

Remember, your total LMI on 3 IPs would be insignificant compared to the CG from your 3rd IP in 10 years.

So if your aim is to get serious with property investments and looking long term then don't think twice about paying the LMI.

 

The full financial implications of LMI are easy to overlook.

Obviously, utilising LMI means you use more of Other People's Money which allows you to retain more of your own and acquire more property and/or for a buffer etc. All makes sense

However.

The real magic happens when you consider, in detail, what that extra property can mean. It's not just about that ONE extra property. It's about being able to leverage that extra property to acquire numerous more properties, then leverage those for more. And so it goes on.

Lets say, as per @devank's example you are able to buy one additional property in year 0 by using LMI.

Lets say it's worth $500,000.

Lets say in 3 years it's worth $800,00 as you bought well/did a reno/caught a growth cycle, whatever.

Lets say you refinance out $200,000.

Lets say you use that $200,000 to acquire another $1.1mil of property in year 3.

Lets say that extra $1.1mil of property is worth $1.5mil in year 6.

Lets say you pull out $200,000.

Repeat.

Repeat.

Repeat.

 

Totally agree Steven, but just try doing that in the current climate - it's serviceability not cash that's hard now for those wanting to build a good sized portfolio.
Also, going to 88%+LMI and then not being able to refinance out more than 80% means you have to get amazing returns (which I think your figures are ) to get to way less than 80% so as to be able to pull out enough - and even then serviceability means you may not be able to buy!

So rather than think you'll be able to buy 3 @ 88%, and then get kicked back on the third due to serviceability, instead buy 2 @ 80% and really make sure you buy better (CG & CF). Having said that, if you can get the CG in 3 yrs you've shown then I'd be awfully happy!

 

It is my understanding that it would be deductible given your intention been to construct an IP.

@Terry_w should be able to confirm this.

 

Push aside serviceability, current lending conditions and the numbers used in my post–it was an example of principles

Assuming identical growth on whatever assets you buy, having a larger $ value of assets will provide you with more capital for use in the future.

I’ve got trapped equity at the moment due to servicing (starting a business will do that) but I have more than twice the asset base I’d have had if I was buying at 80% which will continue to grow whether or not I can access that today, in a year, or in a decade.

 

I think I have some tax tips written about deductibility of interest for construction of an IP These will have links to PBRs some of which apply the same principles to other costs. WIll post soon.

 

Agree building as large a asset base as possible is the key, but clearly that kind of growth is not going to be the norm moving forward. It's been a great ride, but over the next part of the cycle where growth tapers off and a flatlines for a few years, you have be able to live with little growth for a few years. More psychological than anything else. Real challenge is being able to accept in year 6 overall value has grown little, but hold on for year 8-10 and reap the rewards. A lot can't. Those who can will be rewarded, as always. Nothing new. Just need to keep the faith!

 

LMI is the best product ever created. Take it and use it wisely, the return far more than the risk

 

@Redom fair enough - future regulatory change may limit the number of lenders offering higher IP loans with higher LVRs that will be to the deteriment of aggressive , equity/cash tight investors wanting to get onto additional properties though than if there was a host of lenders to borrow I'd argue. I agree I can see the need to preserve equity by paying $5-6k LMI can be hard to quantify in some aspects the 'benefit' becuase it also buys you potentially 8% (if you go 88% LVR as a sweet spot) deposit which you can stick in an offset and use to make minimum loan repayments when a tenant has vacated or there are other issues with the property...

@devank - agree with your analysis of 3 vs 2 properties by using said 88% LVR over 80% for 2 properties. THe only issue though is with 3 properties would be hard to take into account the inflexibility of being able to refinance all 3 loans easily to other lenders for better interest terms or the like given you would have to pay 3 lots of LMI again. At 88% LVR a 450k loan LMI could still be 5-6.5k easily, and at 3 loans you're dishing out nearly $20k in new LMI... understandably the 3rd property shuold bring you in a lot larger CG in the long term you would hope than if you went with the two properties at 80% LVR and could freely refinance at 80% (fees etc but no LMI to pay upon jumping from institution to institution for better products occasionally).

Maybe I'm looking at that the wrong way though?

@Steven - your example is totally on point, but I also agree with macarthurs points. I recently went through the westpac servicability calculator and couldn't service on circa the 85% NO LMI promotion - the monthly repayment on say a circa 450k or so loan is easy enough (say $2k/month), but you throw in $1,700 in assumned fixed expenses, and the worst, 0.25% loan buffers and that's an extra $1k a month in after tax income you need to have for 'servicability'. I don't know if other lenders are as tight, but given everyone says bankwest is conservative (the most) of the lenders and I service with them, I'd imagine the goal posts change quite abit.

THe issue as Macarthur points out is even if you go 88% LVR and use LMI to your advantage, the whole point I guess of havin gthis thread/case studies is how would one go about utilising this in the changing landscape. Macarthur points out what I had on my mind - the fact that you may struggle to get anyone to refinance you equity back from 80% to 88%, even if you already paid LMI on the 88%....

In the past it seems this worked (i wouldn't know as I'm new to the game) but now you would indeed need impressive CG as macarthur pointed out.

This also is pretty hampered given current economic conditions....

 

@Hodor/Terry - yeap be keen to see the tips Terry, if you can post these? I think they would be a good consideration for the next potential construction loan IP. Unfortunately trying to claim my FHB grant/stamp duty exemptions while I can and these disappear. So arguably I'd be caught out in that to access this my original intention would have been 'for PPOR' in the eye of the law... Even if it is my intentions to rent it out shortly after meeting qualifying conditions.... In this case I assume I'd be caught and LMI from settlement of land through to the first day of rental (which could take 2+ years given how long construction takes plus the 6 months FHB residence requirements) before which LMI can start to be deductible. Being conservative and assuming 3 years is the time from settlement of land to rental, this leaves potentially 2/5 of the LMI as tax deductible, of which obviously you'll only see your marginal rate of tax saved... a few hundred dollars i guess, better than nothing, but not as agood as an investor from day 1.

@Jimmy Foxxx- agreed as well. Like you said Steven, asset base is important. Even if stuck in a lender not wanting to go past 80% with refinancingequity, your intiial decision to go 88% LVR I can see how this would have left you 8% to 'multiply' as a next property deposit.

The issue is as Jimmy pointed out - how to finetune a strategy that will work and allow portfolio growth/construction in the 'flatline' years ahead... if equity isn't rising and rents steady if not falling/not that great, how one can expand their asset base I can only see the hard slog of saving money through an income job or other means, putting up your minimum 88% LVR and expanding bit by bit. Slowly the cycl ewill come back and you may be able to repeat this time tested strategy of refinancing equity, but until then does anyone see any other potential way to 'grow the portfolio' any faster?

Besides manufactured equity - i.e. renos, flips, developments, which arguably may be too sophisticated for many investors.

The only thing that may make the house of cards fall down is this strategy of grow grow grow your asset base would unravel if leveraging and the use of OPM and negative gearing and the like were unwound with the relevant tax reviews and calls for their abolishment... alot of vested interests, but if this one day slowly starts to unravel it would be a great domino effect given every man and his dog is borrowing to leverage off this strategy of aggressive portfolio building.

 

This is an interesting question - how to grow in a period of low CG, low or no rental growth, and more difficult lending options. Have we seen anything like this in the last 20 years?

Manufacturing equity using renos may not be useful as the equity gain may well not be enough to offset the 88% loan vs 80% re-equity issue.
Developments may still work well, but are dependent on large loans and presales. Arguably the banks may need to open this up when other investor loans dryup.

Buying fantastically won't matter much in the short term because there's little CG and you've still go to overcome the 88->80% drop.

The only option appear to be to buy in rising market - except your serviceability may not permit it.
The other option is to not grow now, but realise this is a time of consolidation and take the med-long term view and wait it out. For those wanting to be aggressive but yet without a large portfolio, this isn't a nice thought...