Every investment carries a risk. Are You it?
Every investment carries a risk with it. Finding the ideal investment is a balance between return and risk – but the question for many investors is less about the risk of the deal and more about the inherent risk they bring with them through their personal beliefs and behaviours.
I recently saw an example of this during a phone conversation with my friend Andrew. Andrew is a mate and as a policy, I don’t accept mates as clients, but I’m always happy to help them when I can.
Here is his situation. He bought his house a few years ago, paid lenders mortgage insurance (LMI) and arranged an Interest Only period that was about to expire. He has a broker who provided him with four options but seemed reluctant to offer him any advice. Here were his choices:
- Don’t change anything, start paying principal and interest on the loan and begin to reduce the mortgage
- Extend the Interest Only term with the same lender
- Top up the loan with the same lender, place the extra funds in an offset bank account (so no interest is paid until funds are used) and extend the Interest Only period again
- Refinance with another lender
Andrew didn’t know what to do…and at that point, neither did I. How could I know what to do without knowing his plans?
So, I asked him. It turned out Andrew wanted to buy an investment property in the near future. This made the decision making process much easier.
Because Andrew had already paid lenders mortgage insurance, switching to another lender would be a shame, as he can’t get the LMI refunded. It would be a waste of money.
As Andrew wanted to purchase again I suggested he top-up the loan with the existing lender and use the LMI paid as credit for the new LMI. If Andrew had, for example, paid $10,000 in lenders mortgage insurance to borrow 88% of the properties original value he could probably borrow 85% of the new value of the property (which would be higher) and quite possibly not have to pay any further LMI.
I suggested he top-up now as a split loan to the point where no additional LMI needs to be paid, place the new funds in an offset account so he would not pay interest on them until they were used, and he would then have money ready to make his investment property purchase when the time came.
Case solved…or so I thought.
Andrew appeared reluctant, and further probing revealed why. He is afraid of debt. He wanted to refinance the loan now just to extend the Interest Only term and top-up later only when he needed the funds to buy the investment property. He spoke with his broker which advised that he’s 100% confident that he will be able to get finance when he wanted to.
100%? Really?!? How can anyone know the future lending environment? Andrew’s financial situation? The bank’s lending appetite? In my opinion the time to refinance is when you can. This way you have the funds ready to go and can source a lender for the new property, when the time comes, from the broad market, regardless of the specific policy of your existing lender.
But Andrew is afraid of debt, which is why he eventually decided to only refinance without topping up. Andrew is now not market-ready to buy his investment property. His fear wasn’t from the lender but from himself. “I am the risk” he told me “If I see that money sitting there, I might spend it”.
Understanding risk is not only about the risk of the deal but also the personal risk your actions and behaviours will bring to the table. In Andrew’s case he increased his risk of not getting future approval because he couldn’t deal with the temptation of having market-ready cash.
So, what risks do you bring with you? Talk to me today about how you can better control your personal risks when taking on new borrowings.
Here’s to your success,