Leverage Equity: The Real Engine Behind 1 to 20+ - Pt 2

🎙️ TFS Wealthcast – Episode 14 (Part 2): Mastering Equity Like a Pro

In Part 2 of this powerful series, we go beyond the hype and into the real strategy behind leveraging equity to build wealth.

Joined by TFS Financial Planner Sonali Rodrigo, we break down what most investors miss the difference between can you invest… and should you.

💡 In this episode, you’ll learn:

• The true formula for usable equity (and why most people get it wrong)
• How to structure your loans to avoid costly mistakes like contamination
• The 4-step risk framework every smart investor should follow
• Why cash buffers, stress testing, and strategy matter more than chasing deals
• The hidden risks of cross-collateralisation and overleveraging
• What separates strategic investors from reactive buyers

This episode is essential listening if you already own property and want to take your next step without putting your financial future at risk.

🚀 TFS Insight:
At TFS, we don’t just help you access equity we help you use it strategically to build long-term wealth. And with the TFS Loyalty Program, every step you take whether it’s refinancing, investing, or referring others earns you real rewards you can actually enjoy.

Because building wealth shouldn’t just be smart… it should be rewarding.

🎧 Listen now and learn how to turn equity into opportunity the right way.

Any information discussed or provided in this podcast is general advice and has been provided without taking account of your objectives, financial situation or needs, you should consider the appropriateness of this advice before acting on it. If this general advice relates to acquiring a financial product, you should obtain a Product Disclosure Statement before deciding to acquire the product.

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Transcript

SPEAKER_01 0:08

Financial freedom is more than just a gold. Without further ado, let's dive in. Hi guys, and welcome to another episode of the TFS Wealthcast. And joining me today is CWO Sonali, financial planner at TFS. Uh, and we're gonna take off where Pramo left off in the previous week's episode. So this is part two of mastering how to leverage your equity. Uh, without any further ado, Sonali, thank you for joining me on this episode today.

SPEAKER_04 0:42

Thanks, Vish. Good to be here.

SPEAKER_01 0:44

As always. Uh so Sunali, let's jump straight into it, right? So I want to start by grounding this episode in where part one left off. Pramu gave us the execution playbook, how he thinks about equity, how to structure the loans, how the snowball effect builds property by property. What's the financial planner's perspective on all of that? What does Sonali Rodrigo see that Pramu Rodrigo doesn't always lead with?

SPEAKER_04 1:16

Well, this is a point of conversation in a lot of um our conversations, really, because his thing is to find an opportunity, assess it, and then basically say, Oh, let's buy it, right? But for me, I look at it from a point of view not can we do this, but it's more like should we do this, right? Because it has to kind of fit in with the overall uh investment objective, it has to fit in with the overall investment portfolio. So um one of the main things though that Roma and I both um agree on is being ready for opportunities to come by. So um I think he touched on a couple of our acquisitions uh in the early part of building our portfolio. One of the things that um stood in good stead was that we had our equity already organized. So when an opportunity came by, we were ready to pounce on it. So we had to do the due diligence, we had to do the specific research on the property. However, we didn't have to run around trying to organize the finance and getting the equity access and all of that because that was already ready. So um that's something we both agreed on. So then when an opportunity um came uh to our desk, we would look at it, go, should we do this? And if yes, we'll get into it straight away. So um, yeah, so I think from a financial planning point of view, I look at a few things which we've touched on previously as well. Um, I want to make sure like um the cash flow is gonna work, basically. Yeah. Whether we can afford it if something went wrong, if the interest rates went up, if there was a vacancy, like for investment property. Like right now, um, our food spray property is in between tenants. So uh it's at currently advertised on market. We're looking at paper, people are looking at it, we're getting applications now with some new tenancy laws that came into place. There's very limited information you can ask the tenant now.

SPEAKER_01 3:22

Oh, okay.

SPEAKER_04 3:23

So it's getting harder and harder for the landlords.

SPEAKER_01 3:25

So um so like what what kind of information can you not ask tenants?

SPEAKER_04 3:30

Uh my agent tells me you can't really ask uh previous employment history. And then I'm going thinking, well, how can I not know where they used to work? Can I only ask where they were currently?

SPEAKER_01 3:40

Yeah.

SPEAKER_04 3:40

So because that makes it very hard to get like you know, an idea of what kind of person you're getting into. So it's actually in between tenants at the moment, but it's not really bothering me too much because I have factored in buffers for all these things for vacancies. So um, because if I hadn't, then I still have the mortgage to pay, and that I would be, you know, stressed right now. So that's you know, those are the things that we need to really look at from a practical point of view. Um, plus obviously rates are on the rise. So, you know, I need to be able to afford the loan repayments, especially without a rent coming in.

SPEAKER_02 4:15

Yeah.

SPEAKER_04 4:16

Um, so I usually put about two to three percent buffer and then see whether it's something we can still afford. Um, we usually put about 70 to 80 percent vacancy. So that means if it wasn't rented for 30 to 20, uh 20 to 30 percent of the time, can we still afford it? So as long as those sorts of parameters are ticked, yeah, then we say, yeah, let's go ahead and do it. So a little bit deeper level of analysis than what Pramu does from the number side of things is basically what I do. Yeah.

SPEAKER_01 4:47

Basically, you take the role of the planner in the task. So yeah. So you get stuck with a lot of paperwork, I assume.

SPEAKER_04 4:59

Yeah, so um, well, putting a loan application is not that much fun because you have to, you know, provide the lender with a lot of information for them to approve a loan. So it takes a while. Yeah, so that's why again, um, we have all of those things done and ready to go, because otherwise these things can take time, yeah, four weeks sometimes. So, yeah.

SPEAKER_01 5:23

So, so Sunari, uh on that topic, right? Could you could you share maybe a time where you know your planner's instinct stopped you guys from uh making a mistake in terms of buying an investment where Pramu really wanted to buy it, but then you did the research and I think last week he wanted to buy something. Oh, okay.

SPEAKER_04 5:47

Something we have for sale at the moment, I think, with uh sister uh property uh group. But um it's not so much the research, it's just that we're in the middle of doing some other things, so it really doesn't um fit in with the overall um yeah, basically strategy what we're doing right now. Yeah, so I just flat out said no. So because um that's actually an is uh it's a property that's being built. So from uh the type of property, I don't mind new properties because we get a lot of depreciation out of it. Um so that was fine. Um, I was fine with the rental, income, the area, all that sort of thing. But um do we need to buy property in Victoria right now compared when I look at our overall portfolio? Do we need to um have a loan right now while we're in the process of constructing another property and doing a couple more developments? No, so I just said no.

SPEAKER_01 6:47

And there's more paperwork you get stuck with it.

SPEAKER_04 6:49

Yes, so I'm actually in the middle of doing another loan, so you know yeah, it should have just messed up all my plans there. So it's like no, we're not doing that.

SPEAKER_01 6:57

So yeah, that was a very recent where where was his property?

SPEAKER_04 7:01

That was actually in the best and suburbs, oh okay, yeah.

SPEAKER_01 7:06

So uh, so now let's get into the foundational maths, right? I mean, you know, financial planner, you you come from your accounts background, your finance background. You love maths, I'm sure.

SPEAKER_00 7:18

I do actually.

SPEAKER_01 7:20

There we go. So let's get into the financial, uh, the foundational maths, right? So you touched on it, uh, actually Pramu touched on it, but I want you to break it down uh in terms of the usable equity formula properly and walk us through a real example.

SPEAKER_00 7:38

Okay.

SPEAKER_01 7:39

Uh, because I think people hear equity and they imagine a big number that's fully accessible.

SPEAKER_04 7:46

Yeah, so equity um in the simplest form is the difference between the value of your property and the amount of debt you have against it. So, for example, let's say the value of your property is one million um and the debt you have against it is six hundred thousand, you have four hundred thousand equity there. Now, usable equity is not four hundred thousand. Usable equity means how much of that can you actually use? The banks are not going to lend you the 400,000 just like that. Um, they are going to lend you usually up to 80% of the value of the property without paying lender's mortgage insurance. Um, so in my example, if the value was 1 million, 80% of that is 800,000. If the debt against it is 600,000, you have 200,000 of usable equity that the bank will lend to you without you having to pay lender's mortgage insurance. Now, lender's mortgage insurance in itself is not a bad thing. I think Pramod touched on his episode as well. Our person, we've paid LMI. I don't have a problem with LMI.

SPEAKER_01 8:59

He mentioned you guys have sometimes gone into the territory of LMI to buy a property, right?

SPEAKER_04 9:03

Yeah, yeah. So you you make the decision based on okay, can I access more money from the bank by paying a little bit more of a premium, uh lender's mortgage insurance, um, and still have that money work really hard. It depends on what you're investing it into, right? So you have to do the numbers and see whether it's a worthwhile exercise. I must say though, for some professions, like say doctors, accountants, lawyers, um, most of the banks waive off the LMI, so you can borrow up to 90%. So there's that. So it depends on the profession, depends on the person. Um, so we can, you know, have clients borrowing up to 90% without paying LMI. So that's I love that. Um, because that way you can use uh so the usable equity goes up. So in if you're able to borrow up to 90%, in my example, um, you have the lender happy to lend you up to 900,000. Then if your loan is 600,000, you have 300,000 in usable equity, which you can do a hell of a lot more than the 200,000, right? So um, depending on your scenario, yeah, that's how you calculate basically equity versus usable equity. Usable equity is what you can use instead of saving money from scratch like you did for your first home, once the property values go up in value and you do accumulate some equity, you can use that for your next investment property as opposed to saving money from scratch.

SPEAKER_01 10:30

So yeah. Wow, and you did all that maths just like that in your head.

SPEAKER_04 10:35

That's easy, maths.

SPEAKER_01 10:39

So uh so what do you think uh stops people from knowing that they have this available to them?

SPEAKER_04 10:48

They just lack of knowledge most of the time.

SPEAKER_01 10:51

Yeah.

SPEAKER_04 10:51

Um, and they're vaguely aware of this concept of equity, but they're not really sure how to go about using it. Yeah, a lot of people you'll be surprised, think that if they want to buy an investment property, they have to do the same thing that they did for their first home and save up a deposit from scratch. Yeah, right. So um it surprises me with all of the info and the you know the things that you see out there.

SPEAKER_01 11:16

All the property gurus online.

SPEAKER_04 11:19

Some people don't know that still. And you know, to be fair, like if you ask me an IT-related question, some of the basic stuff, some I might not know because it's just not my you know, territory, basically. So I get why um people are, you know, some people don't like talking about finance, they don't like looking into it, their eyes glaze over. So um, yeah, so a lot of people don't know equity is accessible and you can use it towards an investment property. Yeah, I think that's why most people um yeah, don't really use it.

SPEAKER_01 11:50

And I guess some so we've heard this from some clients, they say, Oh, I don't want to refinance my home loan to access equity, you just get me on another 30-year loan, as if it's a bad thing. What do you have to say to clients like that?

SPEAKER_04 12:04

There are pros and cons. It depends on the person, right? So, part of what you know, if a client says that, that's true. So if you've say you've taken a 30-year loan term and you've paid down your debt for let's say three years, your remaining loan term is 27 years. When you refinance, some brokers would extend the loan term again to the 30 years. That means overall, if you look at it, you would end up paying 33 years worth of interest. Yeah, so that in itself is a bad thing because why would you pay extra to the bank, right? Um, having said that, though, there are ways to structure it. You can even go to the new bank with a 27-year loan term if you want to. Yeah, there are some clients who will be like, I'm not planning on having this property for 30 years, I just want to do what I need to do, but still keep my repayments affordable. Then you would extend it to 30 years. There are various instances we would extend it for 30 years, not for everyone.

SPEAKER_03 12:59

Yeah.

SPEAKER_04 13:00

Um, but yeah, so just a blanket statement, it can be correct, it can be incorrect, depending on the client situation. Um, refinancing to access equity, you could stay with your same bank and access equity as a top-up loan. Yeah, you can refinance for better. So it shouldn't just be to access equity that you refinance, it should be a better rate. It should, you know, there are a variety of things you need to look at before you do that.

SPEAKER_01 13:27

So that's good. So, what are some things uh clients should look at right before they refinance or if they're considering a refinance before they go ahead with the lender, what are some things that you recommend they should look at?

SPEAKER_04 13:39

You need to be careful not to get your loan contaminated. What I mean by that is a lot of customers, because they don't know or they don't articulate their um requirements and objectives to the broker or bank, they would just go and say, Oh, I want to top up on my loan. Majority of the time, then the banker would just do a top-up on their loan. So let's say you have a 400,000 loan and you have the ability to top it up by 150, which the client is planning on using for an investment, the the banker or the broker can increase their loan to 550.

SPEAKER_03 14:14

Yeah.

SPEAKER_04 14:15

However, they've done it in one split, so it's one whole pot. Now, your 400,000 might have been for your own occupied property, and then the 150 you took might have been earmarked for investment. However, you have it all mixed in one. That's a contaminated loan because it's very hard to differentiate between tax-deductible debt and non-tax-deductible debt.

SPEAKER_03 14:37

Okay.

SPEAKER_04 14:38

I'll back up a minute there. When you have your own occupied property, the interest on that is not tax deductible because it's obviously you're living in it, it's not used for income-producing purposes. Whereas if you have uh a loan that you took for an investment property, you're generating rental income, and it is agreed by the ATO that the interest on that is tax deductible. So that's the differentiation difference between non-tax deductible interest and tax deductible interest. Now, when you have the loan in one, the problem is it's very hard to figure out what's what and how much of it is deductible and how much is not. So I see a lot of people do this mistake. They just put it all in one, and then when it comes to tax time, they just take the loan statement and that has part non-tax deductible and part deductible. So that's quite confusing, and then you might lose out out on deductions that you could have had. How you probably should look at structuring. I mean, this is how we do it. Um, again, this is not a recommendation, so everything we have to look at properly for your own personal circumstances.

SPEAKER_01 15:45

But guys, if you do need a financial planner, this lady right here, she's a financial planner, provided you can afford her.

SPEAKER_04 15:53

Yeah, so this is general advice only, and I'm saying what I've done for myself. Um, so we would have a separate split, so that way you can identify clearly what is earmarked for investment, and then the interest on that is easily identifiable at the end of the year as well. Typically, it's a separate loan statement that you have for that, and it's very clean, and then the accountant basically, you know, has a very easy time of it. Um, so you would, if you're doing several top-ups or whatever, you might even have a couple of splits. So then, like personally, I have one split that might say food scrape property, I have another split that says Alfredton property, you know, like that. So that way I know what's what as well. When I look log into my internet banking, it's very easy for me to see. So, and then at tax time, it's very easy, get the statement and give it to the accountant. He knows what's what and against which property this should be deductible. So that's something you probably should think about if you are going to access equity, how you structure the loan. Um, yeah.

SPEAKER_01 16:58

Awesome. Uh, so guys, like me, you know, if uh there was a lot of information to digest, you might want to rewind and listen that again because there was a lot of valuable information, right? Uh so Sonali, on the same topic of accessing equity, right? Uh last week Pramu mentioned some of the reasons people access their equity, it's for a cash-out refinance, uh, they do a separate equity split, uh, and also sometimes for a line of credit, right? Now, as a financial planner, which do you recommend and to who?

SPEAKER_04 17:31

I am not recommending anything.

SPEAKER_01 17:33

Okay.

SPEAKER_04 17:34

I will talk through the differences of each, right? Um, so like I said, if you do a cash out refinance and you just do one loan, yeah, it can get contaminated, right? So it's easy, it's very easy for people to understand. There's you have just the one loan to manage and the repayments of one loan to manage. So um, while it's easy, like I said, it can mean you might miss out on certain deductions because it's just too hard to identify what's bought. Um, a separate split is usually what we tend to do for a lot of our customers and what I've done for myself as well. Um, that's easy to identify what's used for which property, um, and it's very clean and clear.

SPEAKER_01 18:17

Yeah.

SPEAKER_04 18:17

Line of credit. Um yes, it's uh an option, but it can tend to be a little bit more expensive than having a separate investments plate. So we usually tend not to do that for a lot of customers merely because it's quite expensive and there's better ways to do things. So those are the kind of differences between you know those three options. But people do all three, I've seen all three.

SPEAKER_01 18:44

Yeah. Uh so uh Sonari, you mentioned uh you know contaminated loans twice now. Uh so can we go deeper on that? What exactly happens and how does it happen and what does it cost someone?

SPEAKER_04 19:01

Yeah, so in the previous example, I said so if you have a home loan for 400,000 and that is your owner-occupied home loan, the interest on that is not tax deductible.

SPEAKER_03 19:12

Yeah.

SPEAKER_04 19:12

So if you um say top up the loan and they've increased that loan to say 550, and you have an extra 150 available, and that you want to use towards um an investment property, the interest on that should be tax deductible, but it's a little hard to figure it out. Then you have to do pro rata interest and all that sort of stuff, right? So that in itself is contaminated. What I see a lot of people doing is they'll say, okay, take 150 out for investment, and then they'll spend 130 on an investment property, use 20 to buy a car. That again is now a personal expense. Okay, right?

SPEAKER_03 19:49

Yeah.

SPEAKER_04 19:49

So now it's further contaminated. So all in that one loan, right? So it gets really difficult to get, and then there's interest that gets um calculated daily, charged monthly. So it all depends on when you bought the thing and all of that. And then the original intention was to use it towards an investment, but then in the middle you've changed the numbers again as well. So it's very hard, and then the ATO obviously would take a very conservative position on all of that, and they'll so people who do this probably disallow some of the deductions, right? So you don't want to get into that. So it's very also important to remember it's hard to kind of fix these things up after the fact. So you're better off getting proper advice before you do anything. So the the best time to get advice is obviously when you buy your first home, you have the unoccupied debt. When you're thinking of an investment, get professional advice, how to structure the loan correctly so that you don't have to kind of try and fix all these things up late down the track and become a real headache for your accountant.

SPEAKER_01 20:55

And if you want professional advice and you want a tailored strategy that works for you, talk to TFS.

SPEAKER_04 21:02

Doing a plug-in, yes.

SPEAKER_01 21:06

So, all right. Uh let's talk about your risk framework, Sunali. Before you sign off on any equity release, before you and Pramu do it personally, or before you advise a client, what tests do you apply? You mentioned a four test model previously.

SPEAKER_04 21:28

Can you for us personally I do a kind of a four test model? It's not, you know, um uh written in stone, but obviously the first one is the serviceability check. Whether we can um we look at the income and then the expenses and all other debts that we have and taking on this debt, can I afford it? If the bank interest rates go up, can I afford it? Um, and then like sometimes that's another thing that customers mix up. Borrowing capacity is not the same as being able to service a loan, right? Borrowing capacity is what the bank is willing to lend you. That doesn't necessarily mean that you should go and borrow that amount because you might not be able to comfortably afford that. The banks, anyway, do their stress testing, usually 3% above the current rate. They will do a buffer and check whether you can repay. However, that's their um way of looking at it. That might not work for you. You might have things planned. You might have, you know, say if you're having a baby and you're taking time off, then a two-income household can become a one-income household. At that time, maybe you shouldn't think of taking on more debt.

SPEAKER_01 22:42

Or having a baby.

SPEAKER_04 22:54

The bank might not know in six months that you're thinking of having a baby, so they'll be fine to lend you, right?

SPEAKER_01 22:59

Sometimes even they might not know that that you're having a baby.

SPEAKER_04 23:02

Well, that's what my father told me, but um, so you know, you have to kind of work it through and see what you're comfortable with. So that's one of the tests that I typically do. Then the stress test is another thing that I do. Now that's a little bit more, okay. So personally, I think about okay, if it's two-income household, if one person is unable to work, what will happen? Um, do I have a cash buffer that I've saved up for emergencies?

SPEAKER_03 23:32

Yeah.

SPEAKER_04 23:33

Now, this is something that you know goes towards the financial planning territory, but I'll still talk about it.

SPEAKER_01 23:38

So usually we get I mean you're a financial planner, qualified financial planner, so you're the only one who can talk about it.

SPEAKER_04 23:43

Again, well, true. But um, yeah, I I like to sit down one-on-one and then talk about the personal financial plans, not so much in general.

SPEAKER_01 23:54

So if anyone wants a financial planner, uh, you should speak to us and see if Sunali is available.

SPEAKER_04 24:01

Um, so first thing I look at is do I have a in an emergency buffer about three to six months of emergency funds saved up? That means am I able to cover all my repayments, my expenses, my mortgages, everything? Three to six months saved up. Um, I usually then, because we've got quite a few properties in our portfolio, have the numbers done so that okay, I've got the rent coming in, how much cash am I out of pocket? Um, I have insurances to cover it, it's personal insurances. So things like income protection. So if I wasn't able to work, that would pay me almost like a salary. Okay. Right? So those things are all set up so that I have peace of mind knowing that I've got the whole portfolio is there, it's not gonna come falling down like a deck of cards if either of us aren't able to work. Now, because we do business, we have a little bit more leeway. Um, if it was a PAYG customer, and if you can't go to work, you'll use up your sick leave and annual leave, and that's it. Then you'll be on nobody, right? So you have to then see what are the what cushioning do I have and safety needs do I have. So that's where insurance plays a large role when we do planning, because income protection is something that we usually do for especially younger couples and families and things like that. Because that way you have your emergency buffer covering you, and then the income protection can kick in if you're unable to work, so that then all your other overall investment and portfolio um goals and things won't get impacted by one person not being able to work. So that's that. And then we also look at the actual property and the cash flow. What's the rent coming in? Um, what are the expenses? How much will the agent charge, the insurance, the body corp, if there's any things like that. Now, I see a lot of investment um almost gurus talk about things like after tax cash flow. After tax, this is only going to cost you the uh cost of a cup of coffee, sort of thing. Sometimes they factor in things like the tax deductions and depreciations into that. So that you will get after you do your tax returns and all of that. So there'll be a timing issue there, right?

SPEAKER_01 26:13

You can't get it immediately.

SPEAKER_04 26:15

You can't get it immediately. Yes, on over like second, third year onwards, you can do like BA by G variations and um things like that, which I won't get into, but you have to see what's the mortgage repayment, what's the rent coming in, and can I afford the out of pocket for all the other bills that will come in, right? Because otherwise you're gonna be short on cash because you're expected to pay those bills and front up the cash for the mortgage. So you have to, you know, understand how the cash flow works and the timing of it as well. So that's very important. Overall, yes, the property might be very good on paper, but you have to see how the timing works as well because your budget has to be, you know, in line with that, right? And then, of course, like I talked about before, the buffers, the buffers, three to six months of um expenses.

SPEAKER_01 27:02

Three to six months, okay.

SPEAKER_04 27:03

Three to six months, I usually say three if it's like a dual income sort of you know, family, stable jobs, you know, um, nothing too risky to think about, but six months if it's like a one person. So because you know, if one person is out of work, then the other person is not working, then that becomes a problem. Yeah, so it depends on your personal situation, but three to six months is the usual sort of you know a good place to start. Yeah.

SPEAKER_01 27:31

So you know, uh to ask a question, right? Now you said if you people can young couples they can get insurance if one person was to go out of work uh where the insurance covers the prepayments. Is there an insurance like that where if a couple breaks up, is there an insurance like that, Sunali? This is off topic. I just want to know. No, there's no insurance as a financial planner.

SPEAKER_04 27:56

Break up, yeah, break up insurance, what yeah, something like that.

SPEAKER_01 27:59

I mean, look, there are couples who bought properties together, they break up and then and then what happens to their property portfolio, they have to split it.

SPEAKER_04 28:09

Usually, if they're a couple and they buy a property together, we've had this before. Yeah, um, we kind of make sure that they have some sort of an agreement on if they break up, what's gonna happen. Yeah, so um we actually quite a few times you'll be surprised how many times I've seen this now. Um, so then they have an agreement on when they would sort of sell, and if they're selling, they would offer it to each other first. If they're able to buy it, then they'll buy it. If not, they'll put it to market. How would the, you know, um, it's kind of like an agreement that they some clients actually go to a lawyer and sign it.

SPEAKER_03 28:45

Okay.

SPEAKER_04 28:45

Um, some just have had that conversation. It's easier for us to have that conversation as a financial planner with them because I'm an impartial third party. Yeah, I'm the one bringing it up. So then it's easier rather than you know, a couple going, oh, what if you break up? You know, it's a bit of a hard conversation, but we do that.

SPEAKER_01 29:03

So I don't think there's insurance, but then we try and sort of there are steps you can take to take to mitigate that to ensure that it's fair play for both parties, correct?

SPEAKER_04 29:12

But even then, of course, you know, couples fight, and then um at the end, um, after or if they separate, then yeah, it's yeah, sometimes.

SPEAKER_01 29:23

So any couples listening, couples listening, you know, there's always the what if possibility. And if you've got a lot of investment properties, you might want to speak to a financial planner. I'm just saying. So, with that being said, so now let's move on to the lawyer, mostly because you that you have to put things in place, yeah.

SPEAKER_04 29:42

Um, well, that becomes like a prenup almost then. Yeah.

SPEAKER_01 29:48

So have there been times where clients had has passed three tests and failed the fourth?

SPEAKER_04 29:53

Sometimes, but it depends on it depends on their situation, right? So some clients they don't pass any tests, but they still want to do it.

SPEAKER_03 30:02

Okay, right?

SPEAKER_04 30:03

So, you know, there's only there's only so much we can sort of outline to them in their decision at the end of the day. Um, and then sometimes clients, you know, have backups in their head. Like we we see a lot of Sri Lankan customers who have property overseas and things like that. So, you know, then in their head or worst case scenario, you know, I'll sell that, you know, those sorts of things do come into play. Um, so yes, then in their head, it's not a risky move.

SPEAKER_01 30:28

So they've got their own buffers then. That's right.

SPEAKER_04 30:31

Yeah, it might not look like your traditional money in the bank sort of buffers, but um, yeah, so as long as whatever the client is comfortable with, right? So if they feel like that's okay, what we can do is counsel them and tell them these are the sorts of things you need to look out for, right? So yeah.

SPEAKER_01 30:50

All right, so now since we've been going deep, let's go deeper on stress testing specifically, right? So when you're modeling a portfolio with multiple properties and donational debt, what scenarios do you actually run? What does a proper stress test look like?

SPEAKER_04 31:08

Um, so I think I touched on before as well. So the bank stress test at about 3%.

SPEAKER_03 31:14

Okay.

SPEAKER_04 31:16

I also try to kind of do similar, maybe a little bit more. Yeah. Um for the interest rate. So rate rises, right? So you check what it is. Sometimes we see customers going, okay, I don't want to really um take the risk, I'm just gonna fix it, right? So um I think early on, Prahmud um mentioned we fixed uh a lot of our investment property rates. Um, we got really good rates because it was COVID level rates, so why not fix it? Um so we had it fixed, I think, for about three years. So then I didn't even have to worry about it.

SPEAKER_03 31:51

Yeah.

SPEAKER_04 31:52

So if I was comfortable with that level, and then for the next three years, this is what I'm gonna pay, then that's a good way to mitigate this interest rate changes by fixing it, right? So um we did that quite a bit. Um, and then another thing we need to check on is the vacancy. Vacancy means um if you have an investment property for rent and if it's available for rent, how how quickly will it get tenanted? So, like I said, currently um the food scrap property, it's not tenanted. So it hasn't been, I think they moved out about three weeks ago. So I've not had about three weeks' worth of rent coming in. So now it's vacant, right? So um, am I able to afford that is something that I usually check and see. Um, if there's no money coming in, do I have enough leeway in my budget to be able to sort of pump money in because the mortgage doesn't stop just because your uh tenant is not right. Um, so that's something that you really need to look at. Um, you also can see what the sort of vacancy rates are in the suburbs. Um, so like there might be areas where there are a lot of own occupiers living and not too many properties for rent. So then the vacancy rates would be very low there because people are you know fighting over each other to get in there. But there might be other areas where the vacancy rates are quite high because there are a lot of properties to rent in that area. So depending on where you're buying, that test can vary as well, right? So just be mindful of that. It's not a standard, you know, sort of rate that you can put because it depends on where you're buying as well. Um, so yeah, those are sort of the two stress tests that I do, and of course, like the income. Um, if one person was not able to work, what happens? Um, and then like I said, for that I do have quite a few buffers going, and with a lot of my planning clients, that's what we do as well. So it it I think the takeaway from this is you have to see what can go wrong and how you can mitigate all of that, right? As much as you can before you get into these things because just going in uh willingly without a plan is a recipe for disaster because things go wrong, like these are not even um things that like rates rising. We're seeing it happening, it's nothing out of the order. It's happening right now, it's happening right now. Vacancy rates happen all the time, right? Properties are vacant and sit vacant for a lot of the time, depending on you know what's going on and the area, and then income disrupts. You might get sick and can't go to work. That happens.

SPEAKER_01 34:35

These are not far-fetched, and the and the properties being vacant, it also depends on if the owners are being realistic with the kind of rental income they get true for that property. It's true.

SPEAKER_04 34:46

So if you if that's what I'm thinking. So I'm thinking to ask my agent, should I reduce the price? Because I feel like okay, even a ten dollar reduction per week, that's gonna cost me for the year like 520 bucks. Yeah, but then if it sits vacant for one week extra, that's gonna, you know, cost me more than that. Exactly. Right? So it makes sense for me to reduce the price and get a tenant in. So you gotta be realistic like that and not be like, oh, I'm never gonna rent this until I get this price, right? So you um we do see a lot of landlords sometimes being a little unrealistic. So I think it's up to the agents as well to kind of educate them and be like, okay, this is what we're seeing in the area. But in this case, I'm trying to reduce the rent, and my agents like, no, no, no, this is what we can get. So anyway, I'll probably yeah, reduce.

SPEAKER_01 35:35

Yeah, I mean, that's something we see with the agents. Some agents, even though the owner of the property is the one that's putting money in the agent's pocket, the agents take the side of the tenants and go get the owner, right? And vice versa. So I guess it's about finding that uh middle ground. Yeah.

SPEAKER_03 35:53

Yeah.

SPEAKER_01 35:54

Anyways. So uh since you mentioned uh cash buffers a few times, Sonali, let's make this really concrete. What's your non-negotiable rule on cash reserves before using equity? Is it always three to six months?

SPEAKER_04 36:10

Or it's minimum three months. I don't think you should go below that.

SPEAKER_01 36:16

Below that, okay.

SPEAKER_04 36:16

Yeah, because see, say for income protection, um, we usually go with a waiting period of about 30 to 60 days. I won't get into too much detail, but for that sort of thing to work, then um to have continuous income, I need like three months emergency buffer, and then the income protection kicks in. So that'll take me up in some cases if you're not able to work for the rest of your life until you your retirement age, right? So um, so then I feel like in my head I've got every angle covered there. So three months is I think the optimal level for me to as a minimum.

SPEAKER_03 36:54

Yeah, right.

SPEAKER_04 36:54

But like I said, if it's a one-income household, it should be a bit more. And you know, um, if you can have more than that, by all means, right? But bare minimum, you should have that before you start venturing out into a bit more adventurous stuff. I think that's what property is right, yeah. So yeah. Um, yeah, without proper yeah, backups and safety nets, I don't think you should do any of this, really.

SPEAKER_01 37:21

In basically in anything, anything in life, right?

SPEAKER_04 37:23

Yeah, correct, right? So you should have a plan for risk mitigation. I mean, um, yeah, very risk-averse, as you can see.

SPEAKER_01 37:32

Now, if you if now, if you're someone who's you know bad at planning, I mean you need to speak to a qualified financial planner. Uh, if you don't know anyone, we have some we have someone in TFS guy. Right? Look, even even if you want to pay and get a financial planner, it really depends on Sunali's schedule. She's very particular.

SPEAKER_04 37:55

I yes, you're right. I I don't want to have to sit here and spend an hour convincing my people should I want to work with motivated clients.

SPEAKER_01 38:04

There you go.

SPEAKER_04 38:06

I mean, yeah.

SPEAKER_01 38:08

So even if you can't afford it, it doesn't guarantee you a slot. Anyways. So Sunari, what are the biggest mistakes you see people making when it comes to leveraging equity? I mean, not the technical stuff we've covered, but the behavioral and structural mistakes that people make in practice.

SPEAKER_04 38:26

Oh, they'll I've seen a lot of structural mistakes, I can tell you that. Um I think yeah, the the contaminated loans, it's just like, why would anyone set it up like this?

SPEAKER_01 38:40

So it also comes down to whoever did it not having the right education.

SPEAKER_04 38:46

Customers wouldn't know, clients wouldn't know these things. It's not, you know, their day-to-day thing to do. So unless you really dive deep into you know research and all of that, you wouldn't know about loan structures, right? Um, so it's up to the person that they go to to be able to educate them and do it correctly, right? So um we've seen a lot of contaminated loans where unoccupied personal sort of um purposes mixed with investment purposes, so it's very hard to differentiate the tax deductibility of that interest. Um, I've also seen uh securities that have been crossed collateralized, which is another um thing that I absolutely don't like because a lot of I think that happens with a lot of the banks. If you go to one particular bank, you have your own occupied and a couple of investment properties there, they mix all of that securities and lend against it, which in itself is not a bad thing. But the problem is when they have crossed all the securities, when untangling that is a problem. So if you want to sell it at one point, they look at the overall LVR and sometimes go, okay, from the sale proceeds, you need to reduce the balances for the other ones.

SPEAKER_03 40:01

Yeah.

SPEAKER_04 40:01

Right? So then they kind of control the sales proceeds as well. So it becomes a problem then. So um, so there's a particular major bank that's a real culprit. They do this all the time, they don't even tell the customer this. It's when you go to, you know, sell one that you find out, oh, the whole thing is cross-tank.

SPEAKER_01 40:20

Is it one of the big four?

SPEAKER_04 40:22

Yes, it is. So um yeah, and they don't even let the customer know, they just do it. But then that's why. So sometimes we talk to the customers and go, let's not go to one particular lender. You should probably look at diversifying because otherwise they have like the whole picture and they can go and do these things and you know, um, without even you knowing, right? So that's one way to go diversify your lender base so that you don't get into this. But again, you can tell the cust uh the banks not to cross. You want a standalone security so that you can decide on that particular security. If you want to sell it, you sell it, and then that money can be used whatever way you want without it impacting anything or having to reduce the debts on the other ones. So um we I've seen a lot of cross-collateralized securities. Um, and then I think some people are over leveraged, let's just face it, right? So they haven't done their buffer testing or cash flow or whatever. Yeah, they've just got the maximum that the bank would lend them, and now they can't afford it.

SPEAKER_01 41:24

They've seen equity and gone, ooh, free money, but yeah, really, it's not free money, exactly.

SPEAKER_04 41:29

It's you need to be very careful how you use it, otherwise, you can go backwards in your financial position by accessing equity, right? So basically, when you access equity, you pay a certain interest rate. What you need to do is make sure that you put it towards something that you get a lot more than that. So with the tax deductions, then you're in a better position and you can create wealth. That's the point of it. But if you're going to access and do other random things with it, then you're going backwards, really. So then you shouldn't do anything. So yeah.

SPEAKER_01 42:04

Uh, on that Sunadi, okay. Now, you know, first-time property investors when they are looking to buy an investment property uh by accessing the equity in their own occupied home. A lot of people want to look for positively geared properties whereby the rental income uh is more than uh the mortgage repayment. Now, realistically, in this current market, where in it's hard to find positively geared properties like that. So, what do you have to say to investors like that who are just looking for properties that will give them more rental income than the annual mortgage?

SPEAKER_04 42:41

Like you said, it's hard to find um in this market because the rates are high. Yeah, right. When the rates were lower, a lot of our properties were positively. But now that the rates are higher, now the it's either breaking even or I have to put a little bit out of pocket. So what I put out of pocket, yes, it is tax deductible. But at the end of the day, personally, for me, property needs to be something that appreciates in value and gives me capital growth over the longer term, yeah. Right? Yes, income coming in, holding cost, um, minimal holding cost is a plus. So by all means, try and get it to as positively geared as possible. Um, but that is not the only thing I look at.

SPEAKER_01 43:27

Exactly. That's what that's what I want.

SPEAKER_04 43:29

Yeah, because just the income itself, you can maybe invest in something else and get that, yeah, right? So you have to look at what it'll give you in the long term because you are taking on a significant debt, a significant risk by doing it. So it should at least give you um capital growth over the long term, not just the income. So, what are you then getting out of it? Because you it it kind of you know pays the mortgage. And then what? And then you sell it, and it's the same price. So sometimes we've seen it going down as well. So you have nothing to show for it, right? So you have to look at what the capital growth um opportunities are, I think.

SPEAKER_01 44:14

And and and I think uh a lot of people they don't know that there are tax depreciations involved.

SPEAKER_04 44:22

No, no. Um, but again, that's a dangerous thing as well, because there are sometimes people just talk about the tax benefits of investing in property. That should not be your sole reason for doing it at all. Um, capital growth, holding costs being fairly minimal, and tax deductions is my reason for doing it.

SPEAKER_02 44:42

Yeah.

SPEAKER_04 44:43

So um we have favored new properties because we get more tax deductions from it.

SPEAKER_02 44:49

Yeah.

SPEAKER_04 44:50

Um, and because we are sort of able to sort of get some opportunities that are off-market, and you know, but yeah, a lot of our property purchases have been um from nomination sales and you know, off-market opportunities. So um yeah, so it shouldn't just be about one thing, it should be, like I said, capital growth, holding costs being minimal, as well as tax depreciation. So depreciation is one thing a lot of um property investors don't know. So what you should do is get a depreciation report, and then you can give it to your accountant and they'll do the rest for you. So you get to deduct, um, basically write off certain things in the property over the course of the um, you know, life of that whatever. So, like, say for example, you know, uh uh an oven might be written off over a five-year period. So then you get to claim that in your tax. So not a lot of people know about it, but um, yeah, that's a blast point, that's a benefit.

SPEAKER_01 45:59

So um I want to touch on one word that we mentioned a few times in the past few minutes. Uh cross-collateralization.

SPEAKER_00 46:09

Right.

SPEAKER_01 46:09

So it's a it's a financial strategy that uh you mentioned that a lot of people use, but they don't know how to use it right. Right? So let's let's give it the full treatment, Sunari. Uh I don't know who better than you or promote would explain this to us.

SPEAKER_04 46:24

It's not my favorite thing to do, but there are instances where we we kind of do it um to avoid things like lender's mortgage insurance. So I'll explain. So in my one of my previous examples, we talked about a property worth a million dollars, and then we had a loan of 600,000. So that LVR would end up being 60% LVR when you take those numbers. Now let's assume that um we had another property that was worth another million dollars for ease of calculation, and then that one had an L VR of 90%, meaning a 900,000 loan against it, right? If you take the value of those two properties together, that's 2 million, right? Then the loans, one has 600, another one has um 900. So the total of the loans would be 1.5 million. Now then the LVR, if you look at the overall LVR, which is 2 million valued properties against $1.5 million loans, the overall LVR would be 75%, which is under 80%. Under 80%. Right? So let's say we were refinancing for argument's sake. Loan one had a 60% LVR, property one, property two had a 90% LVR. We wouldn't pay LMI on the 60% one, but we would have to pay LMI on the 90% one. So to avoid that, a lot of the bankers would cross the two securities together, add the two loans together, and be at the 75% LVR, thereby avoiding lender's mortgage insurance. Yeah. Which is why a lot of people do it, right? Which is not a bad thing in itself. But what you need to be careful of is that now it's crossed. If you were to get rid of one of the properties, let's say you were going to get rid of the one that had 60% LVR, then the lender would be left with a property that is worth a million and has a loan of 900,000 against it. They'll be like, no, no, we don't like that. Yeah, if you told us that you were wanting a 90% um lend, we wouldn't have lent to you. Reduce this to 80 now. So from those sales proceeds, they can be like, okay, we want you to pay money and reduce this loan to 800,000.

SPEAKER_01 48:50

Yeah.

SPEAKER_04 48:50

For us to be able to continue to, you know, have let you have that loan, right? So then they kind of dictate what to do with the sales proceeds as well. So because of those sorts of things, we tend to avoid, but in this sort of scenario, to avoid LMI, sometimes we do it, right? But then, yeah, so it's on a case-by-case basis. It can work, but typically, if we can avoid it, we try to avoid it. So let's say I didn't have a loan of 900,000 here, I had 800,000. Then I had 60% LVA and 80% LVA. I don't need to cross it then. We would do two applications at two separate loans, right? Sometimes brokers and bankers can't be bothered to do two applications. They'll do the one with everything in there. Uh okay. And then, you know, they're like, it doesn't matter, right? But it's usually people sometimes don't know what they want to do two years down the track, right? Sometimes. So then it's best to have it stand alone if you can have it stand alone.

SPEAKER_01 49:51

So, so okay, to clients, uh, you know, potential clients or clients who are listening who probably have their loans cross-collaterized by a broker, right? But they're not sure what should they do.

SPEAKER_04 50:04

Okay, so with with some of the banks, not all the banks, they would list the security on the loan statement, right? So the security that is used would be there and the address would be there. So if it's crossed, it'll have more than one address there on that loan statement, right? Underneath this section where it says security. If you look at your loan documentation, same thing. Under security, it should have the address. If it has only one address, chances are it's not crossed. If it has a couple of addresses, that means they're all crossed. But that alone is not enough. Some banks don't put that on their statements, so you might have to call the bank and check or call your broker and check what's been done. Um, but yeah, if you can untangle it, it's good to untangle it. So we've, I think we've we've helped a lot of customers untangle it and make sure it's all yeah. Um, yeah. Refinancing can be a nightmare when it's crossed as well. Yeah. So you can't refinance one, you have to refinance the whole thing. If you're going to two different banks, then it has to be done on the same day. And like a whole, yeah.

SPEAKER_01 51:09

So, guys, you know, if your loans are all tangled, then you won't want to get them untangled.

SPEAKER_00 51:14

You know, you should speak to a team uh like TFS. Good at untangling.

SPEAKER_01 51:18

Who's good at untangling, right? All right, sonari. So this has been a good episode. So we're down to the last question. Uh and I can see your face that you're happy, like, oh, it's the last question. Finally, I can so uh and I want uh this to be actionable as one with what how Pramu ended uh part one of this series, right? So to someone who's listening right now, if they own their home uh and they've got equity, part one and part two of this series have genuinely resonated with them and they're ready to take the next step. What is one thing they should do this week if they don't to reiterate to I think I mixed up my question here. So to anyone who's listened to episode this episode part two, and they listened to part one, right? And I know they're all ready to actually exactly you know they've got a property, they've got equity, and they're ready to pull the trigger.

SPEAKER_04 52:19

I can buy the whole world. Okay, just please speak to someone who knows what they're doing, please. Because, like I said, if it's very hard to fix it down the track once you've done the wrong thing. If you haven't done anything, that's the best place to start. Speak to somebody, do the numbers. So, first have a look at obviously what is usable equity. We talked about what usable equity was. So then if you speak to a professional, they would most likely organize a valuation on your current property. Sometimes clients tell us that my property is worth this much, but it's not. Yeah, the bank will only take what their value says it's worth. Um, and then looking at your loan to see what the usable equity is. Then we'll do um a serviceability assessment. Can you actually access that equity? Will the bank lend that to you? Yeah, right. Just because usable equity is there doesn't mean the bank will lend it to you. You have to be able to service that notion, right? So then you can get the professional to do a serviceability assessment to see if that works. Third would be loan structure. You have to make sure it's structured correctly. Like I said, don't get it contaminated with your existing home loan, have a separate split or the way you want to structure it. Sometimes we do interest only. I think Pramun touched on um it in his previous episode, where for investments personally, we've done investment interest only, right? So because I want to put as much of my money as possible towards my non-tax deductible debt and pay that off before I start paying off my investment properties, right? Plus it's tax deductible, so you know why not? Um, so do that, and then you can once you do all of that, again, one of my main things is being prepared. So if you have usable equity, you have servicing capacity and you know the structure, put the loan application through and then get it ready. You can park it in your investment split, like Pramu spoke of before, so that when an opportunity comes by, then you can run the cash flow on that particular opportunity, see if it works for you, and then press go on that. So, yeah, that's what they should do.

SPEAKER_01 54:35

Awesome. So thank you so much, Sunali. And for guys uh who've tuned in to part two this episode, uh, who have not yet checked out part one, you might want to check it out because in this series, Pramu and Sonali shared with us how to master leveraging your equity, right? So Pramu spoke on how they did it, uh, what you need to do, things you need to look at, and Sonali touched specifically on how to mitigate the risks involved in uh leveraging your equity. So there was a wealth of knowledge in both these episodes. So when you do have time, do check it out. And you might need to watch it more than once, listen to it more than once to really absorb the knowledge that's been shared here.

SPEAKER_04 55:20

Um, one thing again to remind this is not specific advice. You need to make sure you speak to somebody who knows what they're doing for your particular circumstances because they can see the overall picture, right? I'm just saying, based on my experience and what we did for ourselves, it might not suit whoever's listening. So we need to make sure that it's tailored to their particular circumstances. So if you don't come talk to us, whoever you talk to, just make sure that they do it for you. Don't just say, you know, this is what it should be done. It might not work for you.

SPEAKER_01 55:53

Yeah. You don't need to speak to anyone else, speak to TFS, we'll give you a tailored financial strategy. So, with that being said, see you guys on the next episode. Thank you for tuning in to another episode of the TFS Podcast, where we turn knowledge into action and big goals into real results. Now, don't forget to like and subscribe and share this episode with someone working towards their next financial step. Now, with that being said, until next time, keep building.