Key Post A systematic approach to deciding whether to keep your home as an investment after trading up

[Brendan Burgess]

This has been covered before a few times, most notably in this Key Post, by Sarenco. This post updates it and tries to put a systematic framework on the issue.

If you decide to keep your home as an investment, it is a decision which you should review every few years to see if it's still appropriate.

I attach a Word document setting out this thread as it might be easier to follow.

Stage 1 – Summarise the numbers in an easy to compare format
Stage 2 – Calculate the profit after tax from keeping your existing home as an investment
Stage 3 – Compare the profit after tax to the interest saved through paying the net proceeds off your new mortgage
Stage 4 – Consider the outlook for property prices
Stage 5 – Consider the risk of a tenant who stops paying rent and the hassle of property investment generally
Stage 6 Is your pension adequately funded
Stage 7 Consider selling your existing home and buying a bigger home than planned
Stage 8 Would your existing home be suitable for your children if they go to college?
Stage 9 Miscellaneous issues

 

[Brendan Burgess]

Case study
Current home is worth €300k
Original cost: €180k
Remaining mortgage : €100k
Savings €150k
Target house: €500k
If the house is rented, it will earn €1500 per month
Joint income €150k

 

[Brendan Burgess]

Stage 1 – summarise the numbers in an easy to compare format
It's important to put all the information onto one page in an easy to compare format.

	Keep home as investment	Sell existing home
Existing home	€300k
New home	€500k	€500k
Total property	€800k	€500k
Existing mortgage	€100k
New mortgage (€500k -€150k savings)	€350k
New mortgage ( €500k - €200k equity - €150k savings )		€150k
Total mortgages	€450k	€150k
Net assets	€350k	€350k

Joint income	€150k
Ages	43 and 45
Pension fund size	€200k and €170k
Are you maxing pension contributions	No

 

[Brendan Burgess]

Stage 2 – Calculate the profit after tax of keeping your existing home as an investment

Rental income	€ 18,000	€1500 x 12
Mortgage interest	4,000	€100k @4%
Expenses	€2,000	Between 10% and 20%
Profit before tax	€12,000
Profit after tax	€ 6,000

 

[Brendan Burgess]

Stage 3 – Compare the profit after tax to the interest saved through paying the net sales proceeds off your mortgage

If you sell the existing property, you will have €200k after clearing the mortgage. If you pay this off your new mortgage, you will save €8,000 a year.

So you are better off by €2,000 a year if sell the house.

Factors which affect this calculation

• The level of rent
• The interest rate on the mortgage on the new home
• The interest rate on the existing mortgage

A lower Loan to Value will usually get you’re a lower mortgage rate.

 

[Brendan Burgess]

Stage 4 – Consider the outlook for property prices

In this case study, they are worse off by about €2,000 a year on a property worth €300k. But if property prices rise by 1% a year, it would result in a gain of €3,000 a year or €2,000 a year after Capital Gains Tax.

So any increase in excess of 1% a year, would make them better off in the long-term.

But property prices can fall as well as rise.

 

[Brendan Burgess]

Stage 5 – Consider the risk of a tenant who stops paying rent

Most tenants pay their rent on time and look after the place. But a substantial minority do not. It is very difficult to evict a tenant. A tenant can refuse to leave and can force you to spend a fortune on solicitors’ fees trying to get the property back.

Could you comfortably afford the mortgage repayments for two years without any rental income? If you can’t, you should not hold onto the property.

In this case study, the total mortgages are €450k on a combined income of €150k. They will be able to afford the mortgage repayments if there is no rent.

 

[Brendan Burgess]

Stage 6 – Is your pension adequately funded?

The best long-term investment is via a pension fund.

• You get tax relief on contributions
• The fund grows tax-free
• You can take a 25% lump-sum tax-free on retirement
• You can manage the drawdown of the rest in a tax-efficient manner

If you are already maxing your pension contributions, then this would not be a factor in the decision.

But if you are in your 40s and you have a small fund and you are not maxing your contributions, then it probably makes sense to sell your home, pay down your mortgage and max your pension contributions.

Some people argue that they want to keep their home to have a source of income in retirement. This does not make much sense. The most tax-efficient way of planning for retirement is to max your pension contributions.

 

[Brendan Burgess]

Stage 7 – Consider selling your existing home and buying a bigger home than planned

	Keep house as investment	After selling existing house
Existing home	€300k
New home	€500k	€500k
Total property	€800k	€500k
Existing mortgage	€100k
New mortgage (€500k -€150k savings)	€350k
New mortgage ( €500k - €200k equity - €150k savings )		€150k
Total mortgages	€450k	€150k
Net assets	€350k	€350k

In this example, the couple will have a mortgage of €150k if they sell their home.

With a combined income of €150k, they could comfortably service a bigger mortgage.

If a €500k home is their final home, then this is not a factor.

But if they aspire to a €700k home eventually, it would make sense to buy it now.

Trading up and moving homes is an expensive and risky business. So it’s better to jump two steps at a time rather than one at a time.

 

[Brendan Burgess]

Stage 8 Would your existing home be suitable for your children if they go to college?

This is sometimes a factor. If your new home is not suitable for commuting to college but your existing home is, then it might make sense to hold onto it.

It is very difficult and very expensive to find suitable student accommodation. Having the option of using your own property would solve a lot of problems. And if your children do not go to college, you can always sell the property.

There is a risk of course, that the tenants will not vacate it when you need it, but this is a risk you just have to manage.

 

[Brendan Burgess]

Stage 9 Miscellaneous issues

If your existing home is worth less today that when you bought it, then any increase in its value up to the purchase price will be free of Capital Gains Tax.

For a fuller discussion see here