Education Newsletter December 2010

Is a holiday house a good investment?

How many of us have gone on a holiday and then dreamt of buying a holiday house?

But before you take the plunge there are many factors to take into account, so keep a level head and consider your options carefully.

A holiday house on the coast seems to be a growing Australian dream as we try to get away from the stresses of working in the city, as well as prepare for future retirement.

The purchase of a holiday house, however, can often be a more demanding property investment. Here is some information to help you in making an informative investment choice.

Location

Location is always a critical factor in purchasing property, and holiday homes are no different.

• Prices have soared in recent years in areas on the coast within a couple of hours of the capital cities, so look a little further and choose an area that has not yet peaked and still possesses growth potential.

• Ensure the area is attractive to holiday goers with restaurants, facilities and attractions nearby. There is no point in buying a place by the beach if it’s not within close proximity to those luxuries we all enjoy on holidays.

• Don’t go for areas that have been over developed and are full of brand new apartment buildings as often they will be overpriced and it will lack uniqueness. Also check with the local council if there are plans for major developments in the near future.

• Try to choose an area that is attractive all year round.

Rental Income

As the property will be rented out on a short term basis there will be times when the place will be unoccupied.

While you are searching for a particular area, make sure you find out from the local agents what the average occupation percentages are. This will help you to determine what the rental income per night/week needs to be, and whether this is within the typical rental prices of the area.

Rental Expenses

The advantage of a holiday house is you get to enjoy it for a portion of the year and then claim expenses for the remainder of the year as tax deductions.

As prescribed by the ATO, you can claim expenses such as advertising for tenants, bank charges, body corporate fees, borrowing expenses, council rates, depreciation of items such as furniture, gardening, insurance, land tax, pest control, property agent fees, repairs and maintenance, stationery, telephone, water charges and even travel undertaken to inspect the property.

You can also deduct some expenses from the selling price, which reduces your capital gains tax. These expenses include interest, rates and trips to the property to carry out maintenance.

It should be remembered, though, that annual running costs for a holiday house can be much higher than for other property investments.

In order to attract good short term tenants you need to keep the house and its contents in good condition, as the property needs to be fully furnished.

This means replacing furniture and white goods regularly, painting internal areas, as well as the initial significant investment required on fully furnishing the house.

Therefore, in order to gain significant returns, this should be a 10 year plus investment plan. And don’t forget that when you do manage to use the place yourself for holidaying, there will probably always be jobs to do on the place - so this is by no means a passive investment.

Conclusion

Purchasing a holiday house can be a tremendous growth investment. However, like all major financial decisions, you need to do your research before you take the plunge.

Get ahead on your debts

Debt consolidation is often portrayed as a way out of trouble.

But for many it’s actually a smart way to get debt-free more quickly by reducing the interest being paid.

Many of us have several loans and debts. For example we may have a home loan, a line of credit, car financing, a personal loan, a few credit cards, and some store finance for furniture or renovations. These commitments will all be charged at different interest rates, perhaps with account fees and other charges.

Whilst it may have been logical to set-up and keep these commitments separate, it can mean that you are paying more interest than you have to.

Credit Cards

For example, cards currently have very high interest rates up to 20% and higher, with annual fees ranging from $0 to $295, and interest-free days from nil to 62.

Whilst some of the more expensive cards will have rewards and loyalty programs, these may not make up for the differences in interest charges, fees and interest-free days.

Personal loans, car loans and store finance also show wide variations, with some very high interest rates. For example, interest-free finance through a store is an attractive option provided that the debt is cleared within the term. If not, these loans often revert to extremely high interest rates – 20% and higher are not uncommon.

Balance Transfers

The smart way to reduce this debt more quickly is to minimise the interest rate and fees being charged, whilst maintaining the same monthly payment as before.

A good example is to watch out for low interest or even interest-free balance transfers that are regularly offered by credit card providers. You can apply for a new card and then transfer the balances from other credit cards, which will then be charged interest at a very low rate or even interest free, at least for a period of six months and occasionally for the lifetime of the balance transferred.

This can be a good short term solution, but often the interest rate then reverts back to a (comparatively) high rate. So then the whole process of application and balance transfer has to start again.

Also, this doesn’t help to reduce the interest rates on some store finance, personal loans and car financing.

Smart Consolidation

A more comprehensive solution is to consolidate all of the debts into a relatively low-interest product such as a home loan. The recent reductions in interest rates on many home loans have made this option look even more attractive.

Consolidation can be done by either using an existing spare capacity, for example using available redraw or an unused line of credit, or by refinancing the entire home loan to borrow a larger amount.

This can often result in more than halving your average interest rates. For example you could refinance a credit card at 18.75% to the standard variable mortgage rate of around 7.8%. On a debt of $10,000 this represents a reduction in interest of around $1,100 per annum.

Similarly, by refinancing a car loan of $25,000 at, say, 13% to a home loan of around 7.8% you could see interest savings of approximately $1,200 per annum.

Of course in both of these examples the amount of saving would reduce over time as some of the debt principal is paid off, but it would still be substantial.

Now here is an important point. By keeping the new consolidated payment the same as the sum of the various payments being made previously, then the debt will reduce more quickly as less interest is being paid, so more of the payment is reducing the debt itself.

Words of Caution

This strategy does work, but you should watch out for the following:

• Cancel The Old Debts or Cards. If you transfer the debts (e.g. from credit cards) then you are at risk of building up new debt in its place, which isn’t the idea. By cancelling the old credit cards and loans this won’t happen.

• Early Repayment Costs. Some loans may incur a penalty if paid out early, which can negate some of the benefit of refinancing the debt.

• Establishment Costs. Organising a top up on your home loan, or refinancing altogether, will incur some costs. Again you should check what these costs are and factor them into your calculations.

• Secured Debt. Refinancing personal loans and credit cards using a home loan means that you are converting "unsecured” debt into “secured” debt. In other words, if you became unable to pay the home loan then you would put your home at risk.

Conclusion

If used correctly and by keeping the new payment at the same level as the sum of the old payments, then using your home loan to consolidate your debts is a good way of reducing interest and clearing personal loans and credit card debts more quickly.