REI Expert Guide to Real Estate Investment
Part 2: Get your finances in order and credit ready to apply for a bond
By Neale Petersen
In last month’s issue, we covered the first step to investing in real estate which is to invest in yourself and your education. The second most important step is to ensure that you prepare your finances properly.
Understand your financial statement
Your banker never asks to see your university degrees or school report card. A banker wants to see your financial statements. You must know how to read and understand the three parts of your financial statement: Profit and loss statement, balance sheet and your cash flow statement.
The difference between an asset and a liability
One reason many people are in financial trouble is because they confuse liabilities with assets. For instance, many people think their house is an asset when it’s really a liability. A simple definition of an asset is anything that puts money in your pocket. A simple definition of a liability is anything that takes money out of your pocket.
The difference between capital gains and cash flow
Many people invest for capital gains, meaning they’re betting on the price of something to go up. Unfortunately, today, many people are taking it in the shorts. Investing for capital gains is akin to gambling, only not as much fun. Instead of investing for capital gains, the wealthy invest for cash flow and capital gains are icing on the cake, if they do happen. Your primary investment goal is to improve your personal financial statement. Ask yourself these questions about a potential property purchase:
• How much cash do I need for a deposit for the amount of cash flow I want?
• If the tenant moves out and the property sits vacant, how long can I afford it?
• If there’s a costly maintenance problem, will I be able to afford it? This is another reason to start small. If my friends with the dilapidated house had started with an industrial building, that driveway would have cost them much more and would probably have caused them a much bigger financial problem than the industrial property.
The purpose of real estate investing is to solve your financial problems, not give yourself bigger ones.
Prepare your financial statement
Record all your current income. This could be income from a job, income from assets, income you make working for yourself. Record all expenses including taxes, rent, electricity, school fees, car payments, credit cards, insurance, etc. Calculate your surplus or shortfall to see if you have any funds left over to invest.
Qualifying for a bond
The best is to apply for a mortgage bond through a bond originator as they handle all your applications, paperwork, pre-qualification and know which banks will grant you bonds. When you apply for a bond, one of the first things your bond originator or bank will do is check your credit score, that all-important indicator of the level of risk you represent to the lender.
‘A good score is the key to being able to access all forms of credit including car loans and store accounts as well as home loans – and is based on your history of payment on all previous and current accounts, as well as the percentage of your available credit already being used,’ says Rudi Botha, CEO of BetterBond.
‘It is a quick way for lenders to gauge the probability of you repaying your debts and managing your finances responsibly, and it is so widely used that it is very surprising to us that most South Africans have no idea what their score actually is, or what factors could exert a positive or negative effect on it.’
The different credit bureaux in SA all have slightly different ways of calculating your credit score, he says, but in general scores range from around 350 to 999, and what you should be aiming for is a score of 600 or more. At this level, you should not have any problem getting a loan, provided it is within your means to pay the monthly instalments.
The higher your score is above 650, the more likely you are to be able to negotiate interest rate concessions, which in the case of a home loan can save you hundreds of Rands a month and many thousands of Rands over the lifetime of the loan.
A 0,5% concession on a 20-year loan of R1,5m translates into potential savings of R6000 a year off your home loan instalments, and more than R120 000 worth of interest over the lifetime of the loan. This is why it can come as a big disappointment to find that your credit score is not as high as you thought it would be, especially when you’re diligent about always paying your bills on time. Most of the reasons this could happen are relatively easy to fix.
• The first potential problem is that there have been too many recent inquiries logged against your credit profile. Of course it can pay to shop around when you’re looking for credit on favourable terms, but each time you request a quote, the lender will want to see your credit record, and if your requests are spread over more than few days, each inquiry will be logged separately and it will look like you are applying for several different loans or other forms of credit.
This is one of the reasons why you shouldn’t apply for car finance, for example, at the same time as you are trying to buy a home. It is also why it is always better to apply for a home loan through a bond originator. They only need to pull your credit report once before submitting your application to multiple lenders and ensuring that you get the most competitive interest rate.
Secondly, your lower-than-expected credit score could be your past catching up with you. We often find, for example, that prospective borrowers have black marks on their credit records from years ago because they forgot to actually close an old bank account, for example, and the monthly fees have been mounting up unpaid. Or they may have changed address and missed a bill or two.
Alternatively, you may have had a debt judgment against you and paid it off, but not realized that they needed to advise the credit bureau and have it removed from their record. Sometimes it is just a question of the credit bureau actually having the incorrect information, such as the wrong initials or the wrong ID number and penalizing the client for someone else’s bad payment record. This is why you should check your own credit record at least once a year.
Thirdly, consumers can be penalized not for using too much credit, but for using credit too much. Your score will be lowered if you max out your credit card every month, even if you pay off the balance on time and in full before the due date. What matters here is how much credit you have available and how much you’re using – or your credit utilization ratio – so you should try to keep the balances as low on possible on all your lines of credit.
Finally, not using credit at all can also have a negative impact on your score. Many people have been taught to save for what they want and never get into debt, but if you have no credit history, there’s nothing to show that you’re a responsible borrower who can manage balances and payments. It’s better to maintain at least one active account, like a phone, store or rent account, that you are careful to pay in full and on time every month.
Next month: Part 3: Finding an Investment Property