Finance


Financing The Purchase

The purchase of a property is, for the vast majority of people, likely to be one of the largest personal investment decisions with which the individual is faced during his or her lifetime. The associated financing arrangement is likely to be one of the largest single exposures to debt that the individual will ever face. As such it requires careful consideration by investors.  The process of choosing the right mortgage can be just as difficult and as crucial a choice as selecting the property itself.

As a prospective borrower you should ask yourself the following questions:

  • HOW MUCH SHOULD I BORROW?
  • WHAT INFORMATION WILL THE LENDER REQUIRE?
  • WHAT INTEREST RATE WILL I PAY?
  • WHAT OTHER COSTS SHOULD I LOOK OUT FOR?
  • WHAT REPAYMENT METHOD SHOULD I OPT FOR?


The common repayment method available for our Asian based investors:

Principal and Interest (P+I)

Some borrowers opt for the traditional principal and interest (otherwise known as capital and interest) form of repayment. Your regular repayment, normally a monthly, quarterly or even six monthly, sum would remain unchanged during the life of the loan assuming, of course, that the interest rate remained unchanged. In practice, the repayment would be subject to variation owning to changes in the variable interest rate over time. Each repayment contains an element of both capital and interest and in the early years the interest portion is highest. During the later years of repayment the capital portion becomes higher as the interest portions falls.

The 4-Steps Process

Step1
Understanding what you want

Step2
Matching your investment objective
with the right property

Step3
Getting into Action
- Financing
Leasing and Management
Taxation

Step4
Review and monitor

“I’ve been Alice’s customer for 15 years now and the property investments I made through her have either doubled or tripled in value. Whilst you can never predict the future, I find Alice to be exceptionally good at forecasting market trends, realistically and accurately. She’s my first point of contact whenever I want to make any overseas property purchases.”
~ Ahmad Mustapha ~

Interest Only Repayment

Under this form of loan repayment arrangement only interest (at a floating or fixed rate) is paid to the lender on a regular basis and there is no schedule for the repayment of capital which may normally be repaid in part or in full at any time. It may also be possible to review the interest only arrangement the end of an agreed period with a view to the loan being repaid or renogatioted by extending the term or converting to another form of repayment. This may be at the discretion of the lender.

Although this may be a useful tool in minimizing outgoings and hence maximizing cash flow, some borrowers may benefit more from discipline demanded by a repayment method which requires either regular saving or repayment of capital. In any event, the capital must ultimately be repaid, of course usually by selling the property at good profit.

This is a popular option for property investors.

Interest Only with Lump Sum Repayment

A recent development is the lump sum repayment method. In this way, the borrower deposits or invests a single lump sum at the outset, either directly via a financial institution and repays interest on a regular basis. The amount placed for investment must be sufficient given an assumed, compounded annual growth rate, encompassing the life of the loan, to make ultimate provision for loan repayment. Returns over and above the loan amount would be for the benefit of the borrower and any shortfall would be for the borrower to make good.


Tax and Repayment Methods

Tax and Repayment Methods

There are complex tax implications to consider which vary according to the chosen repayment method. This is a particularly important consideration if you are buying property for investment purposes, looking to let the property and receive income from it. Any net rental income will likely be subject to tax and of course no-one would wish to pay tax if it can be avoided.


The Tax Problem

With a principal and interest loan the interest portion of the repayment continually reduces throughout the loan period. In most countries it is only the interest portion which can be claimed against rental income to reduce tax liabilities. Thus, borrowers find themselves having a reducing interest payment each year and therefore reducing relief against tax, particularly in the case of short-term P+I loans. This problem is compounded with increases in rental income over time. The following chart graphically illustrates this problem.


The Tax Solution

Interest only loans, alleviate this problem of reducing tax relief since the loan amount remains the same throughout the specified period. This enables you to maximize your claim for relief against tax liability on rental income. The following chart graphically illustrates this principle.

A desirable facility is the ability to switch repayment methods during the life of the loan so as to enhance flexibility.


Multi-currency

What Currency Should The Loan Be Denominated In?

The original million dollar question! Once upon a time you would not have had a choice but multi-currency loans are more commonly available nowadays.

Some people express uncertainly as to where they and they families will be located in a few years time, where the principle source of income will be generated and hence the currency in which it will be denominated. Most are trying to avoid the ‘financial handcuffs’ that accompany a typical retain loan arrangement and seek more imaginative package affording greater currency flexibility.

For example, to be locked into one particular currency during the whole repayment period may well be inappropriate given the situation faced by many people in the region. It could well be more appropriate for a borrower to seek a currency switching option whereby he has the facility to finance in one currency today and retain an option to convert into another currency at a later date. For example, a borrower may choose to finance in Australian dollars today and later switch to US dollars should movements in cross-rates present an opportunity to minimize cost or should his or her principal source of income change.

Generally speaking, it is wise to match the currency of your assets with that of your liabilities e.g. Australia-based property and Australian dollar loan would match a fixed asset with the loan ability. May people, however, opt to match more liquid assets such as savings, salary, future provident fund proceeds or even existing assets, with the loan. In this case, the Australian property may be matched with a Malaysian Ringgit loan for example. The choice depends largely upon personal circumstances and future plans, though the ability to switch currencies during the life of the loan could prove valuable at a later date.

Should you anticipate income streams in more than one currency e.g. Australian dollars and Hong Kong dollars, then theoretically you should initially draw your loan in the currency which you believe will weaken relative to the other. If currency switching is available, then once your chosen currency has so weakened you may switch your loan to the other currency and effect a saving in capital.

Anyone considering a mis-match between the currency of the loan and their assets should tread very carefully. Significant movements in currency cross-rates can occur very quickly wiping out any savings through lower interest rates and leaving you stranded. Playing the forex markets with your mortgage monies is definitely not for the faint of heart or financially weak.

As property investment involve fairly large sums of money, is obvious that slight movements in exchange rates against your base currency will also affect the yields of such investment. Yields which may initially appear to give high returns on your investment may be substantially reduced by adverse exchange rate movements.

Multi Currency Loan Repayment PDF