Good budgeting is a skill that can be learned and one which can make a big difference to the serviceability of your loans. Here are some ideas for better budgeting.
Blogger: Steve Waters, director, Right Property Group
The Federal Budget is announced each year in May, accompanied by the usual media comment and analysis. The run-up to the 2015 Budget has been almost unprecedented as multiple ideas are floated about how Australia can be returned to surplus more quickly.
In theory, the options for balancing a budget are quite simple: spend less or earn more – or both! However, in practice it’s never that easy. We know this from managing our own household and investment budgets.
While the current all-time low interest rates are great news for property investors because their interest costs are reduced, they must be careful not to become complacent. In a recent release, Westpac CEO Brian Hartzer announced his bank will tighten lending to property investors. In the past, investors were “stress-tested” when they applied for an investment loan to see if they would be able to service their borrowings at the higher rate of 6.8 per cent.
Since the recent rate cut brings the cash rate down to 2 per cent, you might assume the stress rate would be reduced. You would be wrong: Westpac has increased it to 7 per cent – and other lenders are likely to follow suit! So the recent cut in interest rates is good news for current borrowing, but for your next loan the lending criteria just got that little bit harder.
Good budgeting, a skill that can be learned, can make a big difference to the serviceability of your loans. Here are our ideas for better budgeting.
Create your own P&L
Businesses track their income and expenses on a daily basis and compile a monthly report – a P&L (profit and loss). This report tells the business whether earnings exceed expenses (and they have made a profit) or vice versa – expenses exceed earnings and they have made a loss. It also shows a trend. It might be OK one month to make a loss, as long as this is a one-off and the overall trend is that the business is making a profit.This is a very useful exercise for property investors to employ, for their domestic budget and their property investments. You can use a simple spreadsheet to record your income and spending, or there are apps and other online tools that can help you with this. On the home front, you need your P&L to show you are earning more than you spend and any profit or surplus can be used to pay down debt. One last thing to remember is that the vast majority of us over-estimate our income and under-estimate our expenses… just something to look out for.
Paying down debt
One of the budget challenges facing governments is paying down the nation’s (or state’s, for state governments) debts. These discussions are interesting because at the same time that the government is trying to reduce debt (and the burden of interest payments), it concedes that borrowing to build roads and other infrastructure could be a good thing as it invests in the country’s future and creates new jobs. Similarly, most property investors will be aware of the concept of good debt and bad debt. Borrowing to invest in income-producing property that will increase in value over the long term is good debt. Borrowing for discretionary spending (cars, holidays, clothes and gadgets!) – particularly if you use high-interest credit cards to pay for these – is bad debt and should be paid off as quickly as possible.
An important part of budgeting is forecasting. This is very important for property investors. Are there any foreseeable one-off expenses coming up that will require extra cash – perhaps some maintenance or repairs? Are leases due for renewal and so is there a possibility that your property will experience vacancies? Are you or your partner going on maternity leave, so your income will be reduced for a period? As they say, “forewarned is forearmed”: if you budget for such eventualities you will cope with them better. One way of doing this is by having a surplus.
Maintaining a surplus
What this really means is having savings or a buffer, some cash to cope with challenging times that put pressure on your budget. Disciplined investors will create a surplus by paying themselves first. They work out their regular income and set aside an amount or percentage of their earnings to lock away for emergencies. If you have an offset account attached to your mortgage, then this is a great place to keep this extra cash because it will keep the principal amount of your loan down and reduce your interest repayments in the process.
Each year when you hear the government struggling with its annual budget, it is a great reminder to review your budget and make sure you have it in place for the new financial year. It will help you secure finance for your next property even sooner.