Landlords and property investors must learn to manage their cash flow. Failure to do so could mean your lender might repossess your property.
Good cash flow means having enough money to pay your mortgage and all your bills, on time. Bad cash flow is the opposite. It’s when you start falling behind on your repayments and bills because you do not have enough money.
Bad cash flow leads to late mortgage repayments
Most people assume that having a full-time job is sufficient for sustaining a good cash flow. In theory, this is true. But you’ll be surprised at how many people fall behind on their mortgage 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 previously. This happens when my tenants leave just before Christmas and I struggle to find new tenants until February. 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 knowing it:
Let’s say: your monthly mortgage repayment is £1,000. You easily pay this debt on time during the first year.
By the second or third year, your situation changes. Either, your tenant has left so your property is now vacant; you have a new baby; 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. And over 36 months, this debt will grow to more than £7,200.
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. Failure to manage your cash flow can cause an enormous stress on families.
How can you better manage your cash flow?
To overcome potential cash flow issues, budget how much you need for your monthly mortgage repayments, bills, living costs, and savings account.
When I receive my monthly salary, paying my mortgage is the first thing I do. Then I allocate 27% of my salary towards my bills and living costs, and 23% towards my savings account. These percentages are not a set rule. Set your own percentage that works best for your lifestyle.
Some people deposit all, or most, of their income into their mortgage repayments. This is quite risky if you are a single income earner or have a low salary. If you cannot afford to save money after you’ve paid your monthly mortgage, then the property is too expensive for you.
Contrarily, many property investors argue 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. Cash flow management is a key skill to being a successful landlord and a property investor. Many people forget this until they get into deep financial trouble.
So, how do you manage your cash flow?
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