Archive for the ‘Personal Finance’ Category

Investing: Rental Properties – The Financials Part 2

January 31, 2011

If this is the first of these articles that you are reading, you can still catch up. First there was an article on how to conduct research to find a suitable property. Next there was an article on purchasing and financing a rental property.

This article is about the everyday financials of a rental property. One topic needs special attention.

Gearing

When you are researching for a suitable rental property to purchase you may come across “advice” about the merits of gearing. Or more probably the worthiness of negative gearing. Less often you will hear about positive gearing.

Gearing simply means borrowed money. The amount of borrowed money can be any amount but with a rental property is typically around 80% of the purchase price. So if gearing is borrowed money, what are positive gearing and negative gearing?

Rental properties earn rent income. Rental properties also have various expenses such as rates, insurance, repairs etc. If money is borrowed to purchase the rental property there is also interest payable on the loan. Positive gearing means that after rent expenses and interest are deducted from rent income, there is money left over, a rental profit. Negative gearing means that after rent expenses and interest are deducted from rent income, there is a rental loss.

Where a property is negatively geared, the shortfall must be made up by other sources of money ie savings or income from business or employment.

Some people get excited by the prospect of a negatively geared property because they believe the shortfall will be made up through the taxation system. This is only partially true. It is true that a rental loss can be offset against other income (eg wages), so that less income tax is paid than there would be without the rental loss. However your income tax is only reduced by your marginal rate of tax. Let us use an example:

A has annual wages of $60,000. A’s rental loss on his investment property is $5,000. A’s taxable income is $55,000 and his marginal tax rate is 31.5%. The income tax that A “saves” by having a rental loss is $5,000 x 31.5% = $1,575. So, even after the saving in income tax, the net rental loss is $5,000 – $1,575 = $3,425.

So negative gearing is not the nirvana that some people would have you believe. You need to pay out a net $5,000 during the year to get a $1,575 reduction (or refund) in your income tax when you lodge a tax return to end up with an out of pocket cash loss of $3,425.

On the other hand, a positively geared property gives you net income from the outset. Sure, you will lose some in income tax but again the tax on the rental profit is only at your marginal rate of tax. In the example above, the marginal rate of tax is 31.5%.

So, WHY would you put up with a property that regularly makes a loss? First, the plan should be not to make a loss forever. Property is a long term investment,  NOT for just a year or two. Over time rent income should increase and as part of the loan is paid off interest paid reduces, so the rental loss should over time become a profit. Second over the long term, if you have bought a good property, the value of the property should go up. If you sell the property at a later date you plan on collecting a capital profit, which should ideally more than offset the earlier rental losses.

There will be one final article on the nitty gritty of the financials of rental properties.

 NOTE: Tom On Tuesday IS a CPA but is NOT a tax agent, a financial planner, a banker, a stock broker nor a real estate agent. Please note that all blog posts written on financial matters should not be taken in any way as advice from Tom On Tuesday. This blog post contains general information and the opinions of Tom On Tuesday. This general information also only pertains to Australia. Anyone reading this blog should seek out professional advice for their own personal circumstances before making any decisions.

Investing: Rental Properties – The Financials Part 1

January 26, 2011

So, you’ve found your ideal investment property after plenty of diligent research.

You should also consider the financial aspects of buying and owning a rental property.

Buying the Property

Buying a rental property is not just about the purchase price. There are additional purchase costs. These include:

Stamp Duty on property purchase price – this is an amount charged by state governments on property transactions, so it varies from state to state. It is usually calculated as a percentage of the purchase price. Stamp duty is lowest if the property is being purchased to live in by the owners and is the first property they have ever purchased. Sometimes, for a first home purchase, there is no stamp duty below certain thresholds. There are also some concessions on stamp duty if the property is being purchased by the owners to live in. There are no concessions for property purchased as an investment property.

Conveyancing Costs – this is the cost of a solicitor or conveyancer for their services in preparing all the documents so that the transfer of the property can take place.

Various searches – these are the out of pocket costs that your conveyancer will ask for reimbursement. Many of these searches are fees to search government data bases to determine if there are any planned activities on or near the property (eg new roads etc)

Adjustments on Settlement – the adjustments are for things like council rates and body corporate charges. These adjustments occur because while rates may have been levied up to 30 June or 31 December, the transfer of a property hardly ever happens on those dates. The adjustments are to account for expenses that have already been paid by the previous owner that need to be reimbursed to them.

For all of these purchase costs allow between 3% and 5% of the price of the property.

Financing the Property

Banks typically want a minimum 20% deposit of the price of the property. This deposit can be in cash or another property can contribute towards the 20%. What is so magical about 20% deposit? While some banks will lend on a 5% or 10% deposit, they require additional assurance that the mortgage will be repaid. That means the bank will require mortgage insurance. Mortgage insurance is paid by the borrower BUT protects the bank in the event that the mortgage cannot be fully repaid even after the property is sold. Mortgage insurance is expensive as it will require another 2% to 5% of the property purchase price up front.

Check the latest interest rate deals here.

NOTE: Tom On Tuesday IS a CPA but is NOT a tax agent, a financial planner, a banker, a stock broker nor a real estate agent. Please note that all blog posts written on financial matters should not be taken in any way as advice from Tom On Tuesday. This blog post contains general information and the opinions of Tom On Tuesday. This general information also only pertains to Australia. Anyone reading this blog should seek out professional advice for their own personal circumstances before making any decisions.

Investing: Rental Properties – Research

January 24, 2011

Of all the different types of investments available, one of the most common is the residential investment property. Being a common investment, it is also subject to many myths and half truths. The following outlines some of the basics and rescues the vulnerable from some of the myths.

Research

The first important step in making any investment is research. Understand what it is that you are committing yourself to and what effect your decision is likely to have on your financial future. Real estate people will readily tell you that the key to property is location, location, location. What does that mean?

People are attracted to live in homes that are located conveniently near shops, workplaces, schools, medical facilities, public transport and attractive natural features like beaches and mountains. Rarely though are ALL people looking for ALL these features in the one property. So, who are your potential tenants, what stage of life are they at, how big a property do they need and does the area have the facilities they are likely to value most highly?

The need for research is one reason why a first time investor would be well advised to check their local area first, including nearby suburbs and towns. Since you live there you are familiar with local facilities and have access to local resources like real estate liftouts in newspapers and open houses put on by local real estate agents.

One important thing to keep in mind while researching is that you are NOT buying a proeprty for yourself to live in. You are looking for a property that someone else would like to live in. The difference is that you can buy, say, a smaller property than you live in because it will suit someone else’s requirements. You could buy in a suburb that you would not live in but may have features that are attractive to other people. Try to put yourself in the shoes of a potential target tenant.

One more thing. BE CAREFUL if you are invited to a seminar or induced to take a trip where you will be asked to consider purchasing real estate that is a long way from where you live. For example if you live in a regional area and are asked to conbsider capital city real estate. Or you live is Western Australia and you are invited to look at property on the Gold Coast. It MAY be a good deal but it MAY NOT be. Being taken out of an area with which you are familiar simply makes it more difficult for you to adequately reseach a potential property and to judge whether the price is fair for that area.

You could start your online real estate research here.

Next Time: Investment Properties, the financials. 

 NOTE: Tom On Tuesday IS a CPA but is NOT a tax agent, a financial planner, a banker, a stock broker nor a real estate agent. Please note that all blog posts written on financial matters should not be taken in any way as advice from Tom On Tuesday. This blog post contains general information and the opinions of Tom On Tuesday. This general information also only pertains to Australia. Anyone reading this blog should seek out professional advice for their own personal circumstances before making any decisions.

Your Mortgage – To Fix or Not To Fix

January 21, 2011

Tom On Tuesday phoned his bank in December just before another anniversary arrived on the mortgage. So the question Shakespeare may have posed in this scenario is, “To fix or not to fix, that is the mortgage interest rate question.”

It seems that many people perceive that financial matters are full of difficult concepts. The difference between fixed and variable mortgage interest rates is one such topic.

A variable interest rate means that your financial institution can change your mortgage interest rate up or down at any time. However these changes are not entirely arbitrary.  The Cash Rate, set by the Reserve Bank of Australia, is the basis for changes in variable interest rates. The Reserve Bank changes the Cash Rate as a broad means of affecting the Australian economy. The Cash Rate is also the rate that banks lend to each other overnight.

YOUR variable mortgage interest rate is set by your bank at a margin above the Cash Rate. The Cash Rate since 3 November 2010 has been 4.75% pa. A typical variable interest rate at the moment is somewhere between 7.25% and 8.0%.

Fixed mortgage interest rates are a set rate for a period of between one and five years agreed between the borrower and the bank. Fixed rates are set by reference to banks’ borrowing costs. Fixed rates ARE NOT related to the Cash Rate.

So, which is better, variable rates or fixed rates? As with so many financial decisions, the answer is, it depends. In practice, most mortgages in Australia are on a variable rate. There are some exceptions, such as introductory or “honeymoon” rates where the bank may offer you a low rate for the first year to get your business.

Let me explain with some examples, relevant at January 2011.

Introductory/Honeymoon rate: 7.1% for first year

Standard Variable Rate: 7.7%

Fixed Rates: 1 Year 6.94%; 2 Years 7.19%; 3 Years 7.20%; 4 Years 7.69%; 5 Years 7.89%

So if you are some years into your loan, do you choose fixed or variable? The first thing to note is that the longer you fix, the more expensive is the rate. This is almost always true. Second, the one year fixed rate in this example is considerably cheaper than the variable rate. While that is true at this time of the cycle, it is not always the case. The one year fixed rate tends to be higher than the variable rate when interest rates are at the bottom of the cycle and tends to be lower than the variable rate as interest rates head towards the top of the cycle.

So where in the cycle are we now? No one knows for sure but here is a history of the Cash Rate as set by the Reserve Bank.

So how do I find the best rate for me now? Look here to check current home loan interest rates.

NOTE: Tom On Tuesday IS a CPA but is NOT a tax agent, a financial planner, a banker nor a stock broker. Please note that all blog posts written on financial matters should not be taken in any way as advice from Tom On Tuesday. This blog post contains general information and the opinions of Tom On Tuesday. This general information also only pertains to Australia. Anyone reading this blog should seek out professional advice for their own personal circumstances before making any decisions.

Money – Tom on Tuesday is taking requests

January 20, 2011

Since I started seriously blogging again in December, my posts have ranged across a diverse number of topics, some serious, some not so. I have noticed however that there is a spike of interest whenever the topics turn to money, whether business or personal. So, I have decided to take requests. I invite readers to send me their questions about managing money, personal budgeting or anything about financially setting up and running a business.

A little about my background. I am a CPA (Certified Practising Accountant). I have worked for many years as an accountant for various businesses running their day to day financial matters and preparing regular financial reports for business owners and managers. I have also has several stints working in public practice preparing financial statements and income tax returns for both businesses and individuals.

Here is what I am NOT. Although I have worked as an employee in accounting practices, I have never been a principal able to practise in my own name. I am also not a tax agent. This simply means that I have been qualified and experienced enough to be an accountant and tax return preparer for other business people but never for myself. Also, although I understand many things about investments in shares and property, I am not a financial planner.

That aside, I am prepared to answer financial questions as far as my experience allows. I intend to put the same qualification forward as you would hear for a radio talk back show or you would read in a newspaper column. My advice at all times is general in nature and not meant to be acted upon by any particular individual. Anyone reading my thoughts should get their own specific advice before making any financial decisions.

So what can I do. I can give the benefit of my experience in business and financial matters. I will also be making numerous links to relevant information on the internet. By doing this I hope to cut down on the time you take to wade through the mountains of information on the web.

So, fire away with your questions!

Personal Budgeting – Making the most of your Money

January 20, 2011

Saving for Special Occasions

Jingle Bells – on 31 January it will be a mere 47 weeks to Christmas Day! Depending on your shopping and budgeting habits, this information will bring a feeling of joy or an anticipation of dread. Some will have it all organised. Others will cross their fingers, and trust that the credit card will be paid off before next Christmas! How about using the time (and pay packets) between now & Christmas to put some money aside? That way, shopping for presents and Christmas Day meals will be a little financially easier this year.

From next pay day, put aside $20 a week (or $40 a fortnight) each pay until Christmas. That is $940 you will have to spend on Christmas! What does it mean to “put it away”? Deposit it to a second, card-less bank account until needed; put it safely in a piggy bank; put the money towards lay-buys; pay the money in advance onto your credit card, so that you have a “bank” for present buying.

How do you find the $20/week? Just a few ideas: forgo a weekly takeaway; buy fewer lunches/drinks/coffees at work; “donate” the cost of a pack of cigarettes to the cause.

Even if you plan to spend more than $940 on Christmas, at least you have made a start on paying for Christmas. If instead you put away $40/week ($80/fortnight), you will have $1880 for Christmas cheer!

The same plan works for any other special occasion or particular item – a holiday, new furniture, deposit for a car.

Getting Organised – for many the idea of budgeting is boring. For others setting up a budget is just too difficult. Still others have no idea where to start. This blog is here to help anyone learn more about personal budgeting.

There is an Australian produced product called Moneybags, details of which can be found here. Moneybags supplies a kit that enables anyone to setup, maintain and update a personal budget. You can run a budget for yourself or with a partner. You can run a budget whether you have few financial responsibilities or many. Moneybags not only helps you set up a budget but helps you keep track of how you are going. In addition to expenses, you can also set up savings goals and keep an eye on your progress. Moneybags comes in a compact A5 size folder with full instructions.

If an Excel spreadsheet is more your style, ASIC provides a budget planner here.

What Does a Habit Cost You? – Do you have a habit that you would like to give up? Does this habit cost you money? Could you use more motivation to help you give up? Sometimes putting a monetary value on a habit gives us a different perspective.

Say your habit is eating chocolate. You have decided to reduce the amount of chocolate you eat for your health. But chocolate is just so nice – perhaps you will give up tomorrow! Could the prospect of saving money help you reduce the amount of chocolate you eat?

Say you currently spend $3 a day on chocolate, just on weekdays. Let’s say you decided to only buy chocolate three days a week. What is it worth to you? Savings – 2 days x $3 = $6/week, $25/month, $300/year. What if your habit was buying CD’s? Say, average spend is $60/week. Change that to $30/week. Savings: $1,560/year. The most important thing is to decide ahead of time what you will do with the savings. What are your goals – new clothes, travel, car, a house? Bank the savings and enjoy putting them towards fulfilling your goals!

Why does my Accountant charge so much?

January 14, 2011

Many people in business, especially those new to business, express concern at how much their accountant charges them, especially as it was for “just a tax return”. I hope to throw some light on this issue. 

First, what expectations did you have of the amount of fees you were likely to be charged? Did your accountant prepare an engagement letter setting out the scope of services to be provided and an estimated range of charges for thos services? Even if there was an engagement letter, was it specific and detailed enough and did you, as the client, fully read and understand the engagement letter before you countersigned it? The answer unfortunately, is often too little was established by way of expectations when the professional relationship started. Even if an accountant has quoted hourly rates for partners, senior accountants, bookkeepers etc, there may have been scant attention to the amount of work (ie hours) required to undertake your work. Indeed the amount of work may change as time goes by.

Who are you? – in an accounting sense?

Is your business structure a sole trader, partnership, company or trust? Each type of structure has different requirements and different levels of complexity in preparing financial accounts and preparing income tax returns.

What work have you asked for?

While most business people believe they only need an income tax return, there are other tasks implied in producing a tax return and often other tasks are requested by the client.

Before an income tax return can be prepared, financial statements must be produced for the business entity. At a minimum, this should be an Income Statement and a Balance Sheet.

Trading entities such as Companies and Trusts have additional requirements over a Sole Trader or Partnership. The checklist in dealing with a company or trust is considerably longer than for a sole trader or partnership. Many of the extra requirements are because of the requirements of the tax laws. In addition, it must be remembered that a company or a trust is a separate entity from the owners of the structure. Therefore the flow of funds between the different entities must be properly tracked. Other considerations include preparation of meeting minutes, calculation of Trust distributions and Company dividends.  

There is no simple answer to what an accountant’s fees should be. For business accounting and tax work there is no “industry standard”.  There are a few things that affect the level of fees. Even if a client has done their own bookkeeping, say in accounting software like MYOB, the first question is “Is the work that has been done correct?” This means, as a minimum: bank reconciliations correctly done, BAS returns all correctly done, all coding correctly done. On this last point of coding, it is easy for a client to code something as repairs expense when it should be a capital item that should be depreciated. Loan repayments can be coded to an expense item, when they should in fact come off a loan in the Balance Sheet. If a cursory check of the bookkeeping throws up some elementary errors, then the accountant will want to do additional checking and make corrections. This takes time that you will be charged for.

Even if the client’s bookkeeping is reliable, there still may be some things left to do when the file gets to the accountant. The accountant usually updates the asset register for the business and calculates depreciation. In addition all loan accounts will be checked to ensure that interest and loan repayments have been correctly allocated. Most accountants will scan all the expense codes for reasonableness. Any large or unusual expenditure would be checked and: changed if it incorrectly allocated or if correct, notes made as reminders of what the circumstances were. In addition, all Balance Sheet account balances would be checked. All of this may take some time.

If all the above is okay, the accountant will prepare the financial accounts and tax return in the form they need to be. Even with accounting and tax software this will take a little while to ensure everything is done properly.

Finally, company tax returns involve more work than say a partnership tax return, even in your first year of business. There are particular laws surrounding owners’ loan accounts, where owners have taken money out of the business or have spent money privately. Also when companies pay tax, a “franking account” must be maintained. If you are unfamiliar with franking, I can explain another time. The point being, it is something particular to Pty Ltd companies.

The other thing that you need to take into account about your bill is what other work did the accountant do for you apart from tax returns? If he/she also prepared your individual tax returns and depending upon their complexity, that would add to the cost. As for other work, did your accountant spend any time with you or do any work on your behalf about advising you in setting up the company? Did the accountant do any work like preparing finance applications on your behalf or provide advice on the early stages of setting up and running your business?

The above questions are only ones that you can answer. If your accountant has provided other services or advice beyond preparing financial accounts and income tax returns, then normally those other things would be detailed on the account you received.

One final thing about the difference between competent accountants and really good accountants is that competent accountants will attend to the “score keeping” – preparing financial accounts and tax returns. Really good accountants will be prepared to offer you advice about how your business is going and will provide pro-active advice on where it is going – in conjunction with knowing what your goals and directions are for your business. Sometimes you have to ask in order to start accessing the extra advice. The extra advice will come at a cost but like anything, good advice will add to your business.

If your current accountant is simply providing “score keeping”, then I would first re-consider whether there was more work than usual in the current year and whether or not there had to be some extra work done in addition to your bookkeeping. The fee charged may or may not be reasonable. If you are contemplating comparison shopping for accountants based on the price of “score keeping” then lowest is not necessarily best. Think of cut price haircuts or buying Black & Gold chocolate!

Where you may want to compare accountants is the interest they take in your business and the advice they willingly and pro-actively provide based on their knowledge of your business. The main way to find these accountants is to talk to other people in similar sized businesses and find out who raves about how helpful their accountant has been.

Get more tips and hints on running your business at fixmybusiness.com.au

Taming The Credit Card

December 8, 2010

Is your credit card a friend or foe? Provides pleasure or pain? Is a source of solace or source of grief? Inspires fear or comfort? Read on to discover more about your relationship with one of your important financial partners – the Visa, MasterCard, AMEX or GE Creditline! This is a relationship that will always be close to your heart – or at least your wallet.

Know Your Credit Card Personality (CCP)

To start using your credit card wisely, find out your credit card personality. Are you a revolver or transactor?

A transactor is someone who pays off the entirety of the credit card balance by the due date each month, thus not incurring interest. They make full use of any interest free period for purchases. They do not take cash advances on their credit card as there is no interest free period for cash advances.

A revolver uses the credit card as a revolving line of credit where only a portion of the balance is paid each month. Many revolvers may in fact only pay the minimum required amount each month, as little as 3% of the balance. Since revolvers always have a balance owing, they are never entitled to interest free periods.

How much difference is there between credit cards?

There is a lot of difference! Knowing your own credit card personality is important because it can help find the most suitable credit card for you. These days credit cards have many features whose terms vary from card to card. Different terms include:

Introductory/Balance Transfer Interest Rate: Between 0% and 10%
Introductory/Balance Transfer Period: Between 1 and 12 months
Purchases Interest rate – between 8% and 29% ***
Cash Advance Interest rate – between 8% and 29% ***
Interest Free period – between 0 and 62 days
Annual Fee: Between $0 and $249
Rewards Programs: Yes or No – but each different program has its own rules

*** Purchase & Cash Advance interest rates on the same card are not always equal. In fact cash advance rates can be up to 8% more than purchase rates on the same card.

Credit cards come with all combinations and permutations of different rates and features from the above list, even cards from the same bank. You need to research the features of each one to find the best one for you. You can get more information at http://www.infochoice.com.au.

How do Credit Cards work for my CCP?

If you are a transactor, then in order: interest free periods, annual fees and rewards programs are probably the most important features. Interest rate is less important as you don’t plan to pay any interest! Beware though that if you miss paying in full by the due date, you will pay interest for the full period. Also cash advances always incur interest from the date of the advance to the date of the repayment.

If you are a revolver then these features are of greater importance: introductory/balance transfer interest rates, introductory/balance transfer periods, regular interest rate and annual fee. Longer interest free periods are of no use to the revolver as you always have a balance. Also ignore the temptation of rewards schemes as the potential rewards become very expensive if you are paying high interest rates.

Help! I don’t want to be a revolver anymore!

Most people do not intend to have a long term debt – but life happens – there are necessities and emergencies, shopping trips and gifts for others, several small indulgences – that together all become one large debt.

So what is the cost in the long term of being a revolver?

If on 31 December 2009, you had a credit card debt of $5,000, an interest rate of 16% and you repaid the minimum repayment each month (3% or $150) AND you made no further purchases:

• After one year (31 Dec 2010), you have paid $1,800 in repayments but only reduced the credit card balance to $3,923.
• The credit card will be finally paid off nearly 4 years later (30 Sep 2013). The total repayments will have been $6,657.

How can you get out of debt quicker? Using the same balance and same interest rate BUT a repayment of $250 per month:

• After one year (31 Dec 2010), you have paid $3000 in repayments but the credit card balance has reduced to $2,631.
• The credit card will be finally paid off in only 2 years (31 Dec 2012). The total repayments will have been $5,855.

If you make other one off repayments such as money from a tax refund, the debt will reduce faster.

You can lower the interest paid and the eventual total repayments by using a balance transfer to another credit card at zero interest rate for an introductory period of 6 or 12 months. This strategy only helps if you become a transactor and pay off any new purchases on your credit card at the end of each month.

Please note that all blog posts written on financial matters should not be taken in any way as advice from Tom On Tuesday. This blog post contains general information and the opinions of Tom On Tuesday. This general information also only pertains to Australia. Anyone reading this blog should seek out professional advice for their personal circumstances before making any decisions.