Ask Paul: I owe $1.25 million on mortgages and margin loans
Q. I'm 33 and have two jobs with a combined salary around $130,000.
I have an investment property doing quite nicely and valued at $635,000. I've just purchased a property for $651,000 and rent it out for $750 a week. I have $18,000 sitting in an offset account.
While these two investments are fine, I struck trouble with my shares in the GFC due to a regrettable margin loan and have not been able to work my way out of it.
I have a $130,000 loan against my parent's house (a GFC bailout), a margin loan of $116,000 (the shares are worth $100,000 and dad's CBA shares are security) and have almost $1 million borrowed against the properties.
I'm trying to attack the margin lending first as that attracts the highest rate and sell shares if possible. The shares are Atlas, QBE, Hillgrove Resources, RNI and Nkwe Platinum in order of value. - Brent
A. Hi Brent. Well, you have had an eventful few years. Atlas Iron is a good example of the drama your investments have given you.
The share price hit around $4 in 2011 as demand from China drove iron ore prices to very high levels. Atlas has a high cost of production, close to $66 a tonne. With iron ore below $50, every tonne Atlas produces costs it money.
As I write, its shares are suspended, last trading at 12 cents. So even if you wanted to sell today you could not and, anyway, I doubt it would help a lot.
Given this kind of drama, a margin loan of $116,000 secured against your shares and your dad's CBA shares, along with a mum-and-dad loan of $130,000 secured by their house, to say I am perplexed as to why you would buy another property for $651,000 is an understatement. I think the best thing I can do here is to start with the big picture.
The good news is that your debts should be pretty much covered by your assets. Your total debts are in the order of $1.25 million, assuming the property loans are $1 million. You have $180,00 in cash.
The two properties, plus your much depleted share portfolio, are worth some $1.38 million, so providing these are saleable at the prices you give, you have equity of over $100,000. This is your balance sheet and thankfully it is in the black.
The other important issue is your cash flow. Here I think things are pretty good. Your new property produces $750 in rent. The first is worth a little less so I am going to take a stab at $700 a week. The shares, apart from QBE, will produce no dividends worth noting.
I imagine your margin loan is around 8%, so let's say this means repaying $9000 a year. Your $1 million on property is at 4.63%, so $46,300. Total interest payable is $55,300. But your rent, before property expenses, is $75,400.
So you have a $20,000 surplus of income over interest expenses. I imagine it would cost you about that to run the two properties so realistically I think that they will run at close to break-even. Thank heavens, then, that you have two jobs paying $130,000. This should clear $93,000 after tax.
So on paper, all is OK. You have assets worth more than your debts and you have good positive cash flow. But you are in a position of high risk. If you lost a tenant, interest rates went up or property values fell, you would really be in strife. The question is where to from here?
In your shoes, I would be thinking along these lines. If the properties are well located and attractive to renters, in a climate of falling interest rates I would hang in there. I'd stay variable and I would be expecting to pay under 4% on my mortgage later in 2015.
But if I am not going to sell a property, I would have to reduce risk.
So I'd sell the shares and pay down my margin loan. I would then take surplus income from my work and clear the loan. I would then pay back my parents. Once that was done, I would add to my savings to build a cash buffer to protect myself against the risks in the property market.
So your position is manageable. But I think you are at real risk if anything goes wrong. This could be not only a vacant property, it could be losing a job or getting ill.
So you need to lower risk. If I was in your situation, I'd sell either the shares at a loss or a property.