Comparing Main Bank vs 2nd Tier - The effect of cash flow, capital growth and leverage on after-tax returns.

With ANZ NZ’s largest home lender yesterday announcing amendments to their residential investor lending policy, reducing maximum LVR lending from 70% to 60% I thought it timely to compare main banks to second-tier lenders. While the main bank is a cheaper financing option, the additional leverage that a second-tier can offer, which might accelerate a purchase can have a big impact on total returns.

Let's take a look at an example below:

There are a few key assumptions to highlight in this example.
Firstly I’ve assumed straight-line growth of 6% p.a. In line with long-term historical averages, and this does constitute a level of speculation.
Secondly, I’ve assumed an average gross rental yield of 5% in line with market averages at present, with no increase over the 5-year assessment term.
Thirdly I’ve assumed the borrower's marginal tax rate is 33% and the capital gain is not taxable.
Lastly, I’ve adopted the lowest cost interest rates of 2.39% for the main bank and 3.34% for the second tier.

The key point I’m trying to highlight in this example is that historically most of a rental property's return is derived from capital growth, between 85-96% of the net return from this investment example comes from capital growth.

The old saying time in the market beats timing the market.
So for many people using a second-tier lender to accelerate their investment purchase(s) may be a wise decision.

This approach would not suit all investors/borrowers. Please talk to our mortgage advisors for personalised advice for your own investing / financing situation.

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