When you’ve lived in a house for a long time, you naturally become attached to it. So much so that many people have this romantic notion of keeping the house from which they have moved, and renting it out, believing that it would make a ‘good’ investment.
Aside from this being a very emotional thought, there are real reasons why this is not a good plan.
Here is an example:
Denise and Todd have lived in their home for 12 years. They only owe $150,000, and it is now valued at $750,000. It will fetch $580 a week if they rent it out. It will only have expenses, including loan interest, of $8,000 a year.
They apply to the bank to borrow $1,000,000 to buy their next home. The bank has two securities totalling $1,750,000, so it will lend Denise and Todd the extra $1,000,000 for the new home, because the total debt is only $1,150,000, or around 65% loan to valuation ratio.
The position for Denise and Todd is:
- Their personal debt has an interest bill of $30,000 a year, with no tax benefits.
- The investment debt has an interest bill of $4,500 a year.
- They will make a yearly net income gain on the investment property of $22,160. Since the property is in both names, this profit is split. They each pay $3,324 tax on this income (at 30 per cent tax rate).
- Their total outlay for this exercise is $14,488 (rent less tax payable less interest on both loans less property costs on the investment property).
Let’s see how this works if this is done differently:
Louise and Greg have also lived in their home for 12 years. They only owe $150,000, and it is now valued at $750,000. They move and sell and after paying off debt they have $600,000.
They borrow an extra $400,000 to buy their next home which will cost them $1,000,000. They borrow a further $750,000, to buy two investment properties in affordable areas with 5% rental yields. Total rent is $37,500 per annum.
The bank has two securities (totalling $1,750,000) so it will lend Louise and Greg the $1,150,000 in total.
- Their personal debt has an interest bill of $18,000 a year.
- The investment debt has an interest bill of $22,500 a year.
- They will make a yearly net income gain on the investment property of $11,500. Since the property is in both names, this profit is split. They each pay $1,725 tax on this income (at 30 per cent tax rate).
- Their total before tax outlay for this exercise is $6,450 (rent less tax payable less interest on both loans less property costs on the investment property), which is over $8,000 a year better than Denise and Todd.
BUT, it is important to note that two investment properties would carry a considerable amount of depreciation benefits, which is essentially on paper deductions. These deduction will work to further wipe out the taxable gain, meaning that Louise and Greg will likely not have any tax to pay, making this scenario better again.
You can see from this example that net cash flow is a very big reason not to keep the house you move from. There are many other reasons not to keep your former home as an investment – it may not be in an area that has further growth potential or it may be older and have higher maintenance costs. There are other reasons too, which are more emotional. Could you really stand to watch someone else possibly not take care of a house you have grown to love? If it is no longer right for you to live in, then you should have no attachment to it. Cut the heartstrings and move on – your bank balance will thank you in the end.