Setting up  Line of Credit Loans for the purpose of starting or expanding on your property portfolio is quite simple.

Here is a very basic example;

A couple (lets call them the Cameron’s) have a home that is valued at $500000.00. They have an outstanding home loan debt of $100000.00.

The Cameron’s have a family that are now all at school and as a result are now both working again full time. For the first time in 10 years they find themselves with surplus cash in the household budget and wish to put that to good use by investing in real estate.

So here is how the structure of their Line Of Credit will work;

As mentioned the home has been formally valued at $500000.00. The banks will lend the Cameron’s up to 80% of that with out mortgage insurance. So the maximum loan for the Cameron’s is $400000.00.

Remember the Cameron’s still owe $100000.00 on their home, so this leaves available equity of $300000.00.

They have an excellent income and so serviceability is not a problem, in fact they can afford to borrow substantially more than what their available equity allows.

The Cameron’s have done their homework and have identified three regions that they would like to invest in. They are confident they can buy solid investment properties in each of these regions for $400000.00.

For the purpose if the exercise we are going to assume that in each instance the buying costs will be $20000.00 for each property. Those costs will be things like Stamp Duty, Bank and solicitors fees etc.

So the Cameron’s will set up their line of credit with what we call 4 “Splits”. The first split will be their home loan for $100000.00. The other 3 splits will also be for $100000.00 and each of these splits will be used as the deposit on the three investment property purchases.

Here is how each of those purchases will look.

Purchase price                         $400000.00
Purchasing costs                    $ 20000.00
Total cost of investment                    $420000.00

The Cameron’s will fund this from;
A new loan at 80% of purchase price =             $320000.00
Funds drawn from Line of credit split            $100000.00
Total                                $420000.00

The end result is that the Cameron’s will own;
Their home valued at                     $500000.00
Investment property 1 value                $400000.00
Investment property 2 value                $400000.00
Investment property 3 value                $400000.00

Total assets                             $1700000.00

Their debt structure will be;
Their line of credit loans (4 x 100000.00 splits)    $400000.00
Investment property loan 1                $320000.00
Investment property loan 2                $320000.00
Investment property loan 3                $320000.00

Total Debt                            $1360000.00 (which just happens to = 80% of total assets)

Now I know this is all very convenient with nice round numbers and figures, but the percentages are the important thing to understand.

As you can see the Cameron’s have been able to use their available equity of $300000.00 to “gear” into an investment property portfolio of $1200000.00.

What we would then recommend the Cameron’s do is to pay interest only on the investment properties for at least the next 5 years.

As mentioned the Cameron’s now have high incomes again and can comfortably cover the shortfall between their interest costs and the rental receipts. In fact with the tax benefits that they gain from the ownership of these investment properties, the weekly cost is less than $50.00 per week for each property.

During the 5 year period where the properties are at interest only, the Cameron’s will work hard at reducing their personal home loan debt. In fact they will leave their investment loans at interest only until such time as the home loan debt is nil.

The reason for this is that the interest paid on the Cameron’s personal home loan is NOT TAX DEDUCTIBLE. Where as the interest paid on the investment loans IS TAX DEDUCTIBLE. As a result they would be wasting the tax detectability on the investment loans by paying anything off those loans prior to paying off their personal and NON tax deductible debt.

In all likely hood the Cameron’s investment properties will be either cash flow neutral of positive after 5 years. At this time they can start to use those extra funds to pay off their home loan even faster.

Once the personal debt has been eliminated the Cameron’s will have to decide if they wish to commence reducing the capital of their existing investment loans, why not if they have no personal debt, might as well get rid of the investment debt, OR…

Use the extra equity and cash flow to buy more investment properties.

In all likely hood it would be a combination of both.