It is sometimes difficult to understand the point in paying off a bond on a property if you can afford to pay for it in full upfront. As a buy-to-let investor, it actually does make sense to purchase property this way. Bradley Hancock from Portfolio Property Investments explains:
The following case study outlines the reasoning why it is financially beneficial to use the banks money to finance property investments rather than ones private reserves. Lets assume that we are purchasing a property for 100 000 and that property inflation averages 10 percent per year over a 5 year term. (I have specifically left out the currency as this example can be applied to any country.)
Your Capital Growth on the property would look as follows:
Case 1:You use your own personal savings to finance your acquisition
In this case you would have made no more than the average rate of property inflation. In other words, you would have made a return of 10% per year plus of course any rental income that you may have received less any property related expenses that you may have incurred.
Alternatively you look at the advantages of leverage or as it is also commonly referred to as gearing.
Case 2: You put down a 20% deposit and use the banks money to finance the balance
In this case your investment would have cost you 20 000 of your own money and 80 000 of the banks money. The trick of course is to try and find property that will yield a rental return that will cover your bond repayment as well as any costs that the property may incur.
Although these are overly simplified figures, they do show the general underlying advantage of using the banks money as apposed to your own. In case 2 you could theoretically have applied your 100 000 to purchase 5 properties and then made 61 000 on each of them.
What is however important to remember is not to over do it. Don’t leverage or gear your properties to such an extent that it creates a cash flow problem for you. Try balancing your investments so that the rent you receive can cover your bond repayments as well as any additional monthly costs that the property incurs. You may have to suffer a slight shortfall for the first couple of years, but as the rental escalations start to come through you will soon be breaking even and after a while you will begin to make a monthly profit. At this stage, rather than starting to declare a taxable income, it may well make more sense to refinance the property and use the proceeds to expand on your portfolio. After all the real money is to be made in the capital growth and not the monthly rental income that you will receive.
Why do Property Investors use Leverage to Maximise Their Returns?
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