Managing your cash flow is one of the most important things you need to do as a landlord and a property investor. Failure to do so could mean that, one day, your lender might repossess your property.
Good cash flow is having enough money – either from your rental income, or your salary, or your savings – to pay your mortgage and all the related bills, such as gas, electricity, body corporate fees, land tax, and so forth, on time.
Bad cash flow is the reverse. It’s when you don’t have enough money so you start to fall behind on your bills and mortgage repayments.
Bad cash flow leads to late mortgage repayments
When purchasing a new property, many first-time buyers focus more on the purchase price, the deposit required and the monthly repayments.
Many new buyers assume that having a full-time job or a stable income is sufficient for sustaining a good cash flow. In theory, this is true, but you’ll be surprised at how many people slowly fall behind on their repayments.
21 properties are repossessed everyday in the UK, according to the December 2017 statistics from the Money Charity. Whilst, in May 2017, the Digital Finance Analytics (DFA) estimated that 52,000 Australian households were at risk of defaulting on their mortgages.
Admittedly, I’ve fallen behind on my mortgage repayments a few times, especially when my tenants leave before Christmas and I struggle to find new tenants until February, as everyone is on vacation.
First signs of cash flow problems
Here’s a common scenario of how you could be experiencing cash flow problems without even knowing it:
Let’s say your monthly mortgage repayment is £1,000, which you easily pay on time during the first year.
By the second or third year, the situation changes. Either your tenant has left so your property is now vacant; or you have a new baby; or you’ve been made redundant; or you’re now the carer of an elderly relative.
This change of situation means that you can now only afford £800 of your £1,000 monthly repayments. To cover the difference, you start to withdraw £200 from your credit card.
Withdrawing £200 from your credit card seems like a small debt, but what happens if it accumulates?
Over 12 months, this debt will grow to more than £2,400. Over 24 months, this debt will grow to more than £4,800. Over 36 months, this debt will grow to more than £7,200.
It’s a very sad truth that accumulating debt and bad cash flow management causes thousands of people to default on their mortgage and lose their homes. This has happened to my parents. Bad cash flow can cause an enormous stress on families.
How can you better manage your cash flow?
To overcome potential cash flow issues, you should budget how much you need for your monthly mortgage repayments, you bills, your living expenses, and your savings fund.
When I receive my monthly salary, the first thing I do is pay off my mortgage. Then I allocate 27% of my salary towards my bills and living expenses and 23% towards my savings account.
The above percentages are not a set rule; you should set a percentage which works best for your lifestyle.
If you cannot afford to save some money, then you can’t afford a house
Some people deposit all or most of their income into their mortgage repayments, but I think this is quite risky if you are a single income earner or have a very low salary.
If you cannot afford to save any money after you’ve paid your mortgage, bills and expenses, then the property is too expensive for you.
Contrarily, many property investors argue that it’s better if your yearly expenses exceed your yearly mortgage repayments because the income loss is tax deductible in some countries. This is known as negative gearing.
One of my properties in Australia is negative geared, and I have benefited from claiming tax deductions.
However, if you’re a single income earner, think very carefully about adopting the negative gearing strategy as you’re more likely to struggle if interest rates rise, or if you lose your job.
Remember, just as ‘every little bit’ helps when it comes to saving money, ‘every little bit’ can also add up very quickly if you have debts. It’s a key lesson to being a landlord and a property investor, which too few people take into consideration until they get into financial trouble.
So, what tips do you have on good cash flow management?
Please note, though I own a few properties, I am not a legal, financial or professional property expert. I’ve written this post to share my personal experiences and would love to hear your opinions and views.
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