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This month our featured question is from Stephen Wagener from NSW. Congratulations Stephen. You win a Cash Flow Secrets DVD set. It's on its way!
Stephen asked:
"Hi Team the info in your newsletters are great however the comparison of LVR's was very confusing. Would you be able to prove the workings with a detailed explanation? Kind Regards Steve"
Steve's question relates to Michelle Coleman's article last month (click here to view) on the new 80% and 85% LVR Low Doc Cash Flow Mortgage™ products. Specifically Michelle's point that:
"...What investors have always had to consider when analyzing this product was that if their property didn't go up in value enough, the rollover won't work as effectively and their cash flow could become worse off.
However as you can see from the comparison below the minimum capital growth requirement is now less than 6% to make the rollover work vs the original version when it was around 9%.
For an 85% CFM loan:
Property today: $500k;
Starting LVR: 85%
Maximum LVR at 2 year mark: 90% (3%, i.e. $450k)
Rollover amount: $450k
At 85% LVR, property value needs to be: $529,412 ($450k/85%)
Value increase for property over 2 year: $5.88% ($529,412 - $500,000)/$500,000)
For an 80%CFM loan, as a comparison:
Property value today: $500k;
Starting LVR: 80%
Maximum LVR at 2 year mark: 87% (i.e. $435,000)
Rollover amount: $450k
At 80% LVR, property value needs to be at: $543,750 ($435k/80%)
Value increase for property over 2 year: $8.75% ($543,750 - $500,000)/$500,000)”
This month Lee Dittmer, one of our Melbourne Strategist's provides a more detailed explanation of the numbers for Stephen...
For the 85% CFM:
For the $500k property in the example the loan starts off at 85% (actually a bit higher because the fees can be added), but we'll keep it straight forward. If the property doesn't increase in value, after 2 years your loan is 90% of the value of the property.
If the property has done the right thing and increased at the expected 10% per annum by year 2 it would now be worth $605,000.
At this stage you can Rollover the loan and take the loan back up to 85% of the new property value and release $60,000 in new equity to potentially make another purchase.
Let's say the property has only increased in value by 5.9% per annum, your property would still be worth $560,000 and you would still be able to release $22,000 in new equity.
If you didn't want to release new funds but wanted to take advantage of the higher capitalised interest again, then the minimum value of your property would have to be $529,000.
Your loan is now $480,000 so the property would have to value at least $529,000.
For the 80% CFM:
For the same $500k property an 80% lend starts you with a $400,000 loan. With a 10% growth pattern you would be able to release $47,000 in new equity by Year 2.
If however your property had increased by 5.9% in Year 2 then you would only be able to extract about $12,000, because your property would be worth approx $560,000 and you can take the loan back up to 80% of the value.
If you didn't want to release new funds but wanted to take advantage of the higher capitalised interest again, then the minimum value of your property would have to be $547,0000.
Your loan is now $437,500 so the property would have to value at least $547,000.
So you can see in both instances that with a lower property growth, the benefit of the 85% loan is:
1. You are contributing less of your own funds in the first place.
2. You can extract more equity with a lower growth pattern than with an 80% loan
3. The property doesn't have to increase in value as quickly with an 85% loan to get the capitalised interest savings.
I hope this explanation provides some more clarity on how the product works. It's a good question because doing the numbers on potential investments can be confusing!
Especially if you aren't familiar with all the ins and outs of the product.
I do find it easier to go through these scenarios in person, whether it be in a phone meeting or a face to face consultation. (It's always difficult when things are in written in jargon!)
If you are interested in finding out more and maybe running a few of your own personal scenarios through our model, you can call 1300 663 836 to speak to a Strategist in your state.
We are more than happy to help you do your sums!
Hope this helps.
Regards,
Lee Dittmer
Investment Mortgage Strategist
Melbourne
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