There are ways you can finance your property even with a small capital beginning with asking for a mortgage/bank loan.
Asking a bank or similar financial institution to pay for your property purchase is the most well-known and often used option. It is typically also one of the cheapest solutions available. In Singapore for example, mortgages can be obtained for a mere 1% interest, in Australia, Europe, UK, and US they might range from 3% to 5% or so. The actual interest rate that you can get depends on a variety of factors such as currency, the current market environment, tenure, loan size, your credit worthiness, and which bank you ask. Shopping around and comparing the different options that are available to you is essential as a mere 0.1% better interest rate makes a huge difference in payments over the life span of the mortgage. That’s why you need a good mortgage broker on your team.
The amount of the mortgage also depends on a variety of factors such as the value and location of the property, your income, the potential rental income and your credit worthiness. If you are able to obtain a mortgage for a low interest rate, you might want to consider financing your property largely by this option.
There are different types of mortgages available that come with different features and options that I will be explaining to you:
- Repayment versus Interest Only
- Fixed versus Variable
- Lock-in periods and fees
What many people are familiar with when they hear the word mortgage is the repayment mortgage. In the monthly installments, there is a component of interest as well as capital repayment over the entire duration until at the end of the tenure, the loan amount plus interest has been paid. In the beginning, most of the monthly payment goes towards interest and only a small part towards repayment, but with each payment as the outstanding loan amount reduces, the portion that goes toward interest reduces and the portion that goes toward repayment increases. Towards the end of the loan, almost the entire monthly payment is used to repay the capital. This is what we call an amortization loan.
Taking up a repayment or amortization loan might make sense for the house that you live in, as you don’t likely intend to sell it any time soon. For an investor, it is not the best option though as the monthly payments tend to be rather high (of course depending upon the tenure). So what is a better option then?
The solution is called Interest Only Loans. This means that you only pay the interest to the bank for your monthly installments, but there is no repayment component. You might be asking, so when do I pay back the loan? Well, quite simply in a lump sum either at the end of the tenure or when you sell the property, whichever comes earlier. The two key advantages of using Interest Only Loans are that your monthly payments are significantly lower and hence you have a better cash flow and over time inflation makes your property (real asset) worth more and your debts (financial asset) worth less! Let me give you some numbers to illustrate this.
A mortgage greater than $100,000 for 20 years at 3% interest costs you $555 per month for the repayment option, but only $250 for the interest only option. And considering an inflation rate of only 2% after 20 years, your $100,000 debts are worth only $67,297 in today’s terms – at a 3% inflation rate, they would be worth only $55,367 in today’s terms! Do you want to let inflation work for or against you?
The next decision you need to make is whether to go for a mortgage with a fixed or a variable interest rate. A fixed interest rate loan gives you security that the interest rate will not change for the number of years it was fixed. The interest rates for variable interest loans are typically fixed to certain benchmark index interest rates such as LIBOR (London Interbank Offer Rate) or the bank’s internal housing loan benchmarks. Therefore they fluctuate, which can be an advantage if they decrease, but a disadvantage if they increase. Often, variable interest rate loans are cheaper than fixed interest rate loans as they carry less risk for the bank, but more risk for you in case of rising interest rates. As on overall recommendation you should have a mixture of both types across your property portfolio.
Please also carefully consider the fees that you need to pay as well as lock-in periods before you sign on the dotted line. Lock-in periods usually range between two to four years during which you are not able to repay your mortgage prematurely unless you pay a hefty penalty.
What these different types of mortgages have in common is that you will need to pledge your property as collateral. In other words, if you don’t make your mortgage payments in time, the bank will take the property away from you and auction it off (for potentially a low price) so it can recover its loan. Therefore, you better make sure that you pay on time.
In some countries, there are credit bureaus that assign credit ratings or scores to people and companies. This is supposed to give an indication on the credit-worthiness of the person or company and is widely used by banks during their decision-making process whether to approve your mortgage application or not. If you invest in a country with a credit bureau, you might want to check on your score and ensure that you build up a good rating over time by paying all your installments always on time.
The Property Apprentice Master, Jochen Siepmann, wants to share the wealth of his knowledge easily and effortlessly with you for FREE. Start your journey now to greater wealth through passive real estate income and capital appreciation with one, or all, of these FREE offers: