Money matters: Safer to postpone small-town dreams

By MARY HOLM

Q: We have enjoyed some years of being cash rich and asset poor. But now it's time to rethink our strategy.

We do not own our own home, but rent and will do so until my husband turns 65 in four years.

I am the main breadwinner and what I earn, if budgeted carefully, can just cover our high city costs. But we want to move to a rural town in the Bay of Plenty.

My husband does contract work, which is our only way of saving. We have $45,000 in Colonial First Tasman Shares Trust, $65,000 in the BNZ Balanced Fund, $10,000 in a business we are involved in, and $5000 on term deposit.

We are looking at buying a property in the rural town, which could be rented out for the next two to four years, using $70,000 of our investment money.

On a property worth $145,000, we would have a $75,000 mortgage. This would only just be covered by rent.

We have planned that by saving $15,000 a year, we could have the property mortgage-free for ourselves by retirement, and still have money invested.

But there is no leeway for high interest rates or contingencies. Are we spending our money too soon?


A: I would probably postpone the rural purchase until you're ready to move to greener pastures.

Although your question looks different, it is similar to the one in last week's column about borrowing to invest in shares.

In your case, you would be getting a mortgage to buy rental property. But the basic issue is the same: borrowing to invest in anything raises your potential returns, but also your risk.

I'm going to assume that, whether or not you buy the property now, you will still save $15,000 a year.

So we need to look at whether you'll be better off, on your retirement day, if you:

* Borrow $75,000 and put $70,000 of your savings into a rental property now, or

* Leave the $70,000 invested, and buy a home when you retire.

If you buy the property now, you will gain by any growth in its value, until the time you live in it.

I say "any," though, because in some smaller towns property values have fallen recently.

It would pay to find out the trends in the town you have your eye on. And don't ask a real estate agent if you want unbiased info!

You will also gain by repayments of the mortgage principal.

In your calculations that showed the rent would just cover the mortgage, were you assuming a 20 to 30-year loan?

If so, most of your mortgage payments will be interest in the first few years, so the principal repayment won't amount to much. But if you were considering a shorter-term loan, you could whack quite a bit off the principal.

And did you take into account that you will be able to deduct mortgage interest payments and expenses such as rates, insurance and maintenance, on your tax return? That can be worth a few thousand dollars.

Another advantage of the rental property is that you could put your $15,000-a-year savings into repaying the mortgage.

That means you effectively get a tax-free return on those savings of whatever the mortgage interest rate is. And it's risk-free.

If you don't buy the rental property, you won't get as good a return on those savings unless you take on a fair bit of risk.

Against all this, consider how you'll meet the mortgage payments if your rent is lower than you hoped, or if you lose tenants and can't find others for a while. In a small town, that's quite a possibility.

And what if the tenants ring to say the roof is leaking, or damage the property?

It's hard to organise and supervise maintenance work at a distance, and to keep an eye on what the tenants are up to.

Another worry, as you point out, is that mortgage interest rates could rise. They have dropped recently but, over four years, who knows?

If you don't buy the property, and leave the $70,000 invested, at retirement you can add it to your $15,000-a-year savings and buy a house then.

There are some risks in this option, too. Your Tasman trust investment holds New Zealand and Aussie shares. It's possible, although unlikely, that its value could fall over four years.

It's highly unlikely, though, that your balanced fund - which invests in cash, fixed interest and shares - would lose value.

And there's a fairly good chance that the share investment, in particular, could grow faster than a property in a small town.

Perhaps you feel it would be easier to discipline yourselves to save if you already own the house you will retire to.

But if you plan to buy a house in just four years, that gives you a pretty clear goal.

Weighing up all of this, it seems that - unless you expect house prices in the town to grow unusually fast, or you haven't taken into account considerable mortgage principal repayments, tax deductions and so on - you'd be better to stick to the status quo, plus saving.

And it would certainly be the easier option. That's no small consideration.

Q: I was interested to read in your column last week that you advised one of your readers that they can claim interest payments for their mortgage as a tax deduction if they invest borrowed money in shares.

You seem to be suggesting that anyone who is paying interest on a mortgage and also has money invested in shares can claim a tax deduction. Is this correct or am I missing something?

My wife and I have a mortgage and have also just recently invested $8000 in two separate passive unit trusts covering international shares.

Does that mean that we can also claim the interest payments on the $8000 as a tax deduction?


A: Sorry to raise your hopes, but no. Well, not really. Read on.

You can deduct the interest only if "the money was borrowed for the purpose of making an income-earning investment," says an Inland Revenue spokeswoman.

She acknowledges that, whether or not you did that, the end result would be the same: you've got a mortgage and an investment. But it matters how you got into that situation.

This all seems rather unfair to me. But don't blame the IRD. Blame the politicians who made the law.

I asked the spokeswoman what would happen if you cashed in your unit trust investments and reduced your mortgage. Then, some time later, you increased the mortgage again, and used that money to make a new investment.

Could you then deduct the interest on that new loan?

"If they were simply restructuring their affairs to enable them to get deductibility of their interest, we might look at it for tax avoidance," she said. "If we thought it was tax avoidance, there might be a penalty."

To be on the safe side, then, you would need to have another reason for making the moves you made.

Given that getting out and back into your investments would cost you fees or brokerage, it might be better to leave things as they are. But if you're going to make more investments, perhaps you could set things up so that you borrow to do it.

The spokeswoman added that people often get caught out if they borrow to buy a house to live in, and then rent out their old mortgage-free house.

They can't deduct mortgage interest, because the reason they borrowed was not to buy an income-earning investment. Again, it's not fair. Time for some political lobbying?


* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@journalist.com. Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice outside the column.