The secrets of banking and investment property loans
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We’ve reached episode 10 – fantastic! Thanks to all of the listeners who have been with us or found us along the way.
In this episode we talk about fuzzy holiday brain and why this makes you think that all property looks like a bargain when you are on holiday. We talk about excuses for not investing.
Our feature segment is about banks and loans for property investing. This covers costs associated with loans, assessing various loans, types of loans and who to speak with to find good advice. As always, our advice is general and for educational purposes, we recommend that you seek professional financial advice when it comes to the right loan for your situation.
Quick Tip – In our quick tip, we give you a quick method for calculating how much interest rate changes will affect your loan. Basically, every 1% change means approximately $80 difference on a $100,000 loan.
Also, fortnightly repayments are a good way to sneak an extra repayment in without you noticing it and reduces overall interest in the long term.
- Find a mortgage broker who knows about property investment and setting up finance structures for investing to be part of your property investment team.
- Make your decisions with professional advice – your accountant. Make sure your accountant is a property investor!
Our listener question comes to us from Aaron, all the way from California! Aaron asks about ‘turn-key’ investment companies and whether using this sort of company is a good thing or risky.
This is Everyday Property Investing episode 10. The show empowering everyday people to create wealth and financial freedom, so get on board! Anyone can be a property investor. It just takes a little knowledge, a little support and some action. So get started with us today!
Den: Hi and welcome! I’m Den and this is episode ten of Everyday Property Investing. In this episode we’re going to talk about banks and loans, which is very important topic when it comes to investing in property. And this episode’s Quick Tip, we’ll help you with a quick calculation. I’m here with Kaz and we’re here to help you develop your knowledge and ours, and to share our experiences with our Everyday Property Investing community. How’s it going Kaz?
Kaz: Great, thank you Den. How are you going?
Den: Yeah, really great. So tell me what’s news with you?
Kaz: Well, I was recently on holiday I think I might have mentioned that. I mean it’s a little while ago now, but it was just I had another sort of topic that I wanted to talk about from that. And that is buying property when you’re on holiday, I don’t know about you but when I go on holiday.
Den: Everything looks good.
Kaz: Great! That house in tropical north Queensland just looks like a bargain, doesn’t it?
Den: Yeah I think somehow when we are holiday our defences are down a little bit, but everything looks awesome.
Kaz: I know and I always want to move to wherever I’ve gone to, so that we get there and we go ‘right, that’s it, we’re moving here.’ That’s it we’re selling everything up, the property is great, we’re going to buy a holiday house and come up and visit it three months of the year or something like that. And I guess the point I wanted to sort of bring up about that was that just to remember when you’re on holiday that your mind isn’t working quite as it usually is and so you should make sure that you run any potential deal through your normal financial filters.
Den: Go through your work brain as well as your holiday brain?
Kaz: Exactly, or just make a rule, a blanket rule, I don’t buy property when I’m on a holiday.
Den: You know it sounds really stupid but it’s so true. And it’s so important that people understand just because you go to wherever for a holiday suddenly you can’t just buy the property here and it’s not necessarily as great and yeah it’s really, really important.
Kaz: Yeah fuzzy brain on holiday. What’s about, what’s happening with you Den?
Den: Well it’s funny I’ve been just having my normal conversations with people and more and more of the people I deal with on a day to day basis, who are aware that I do this, who’ve been speaking to me about property investing and specifically the reasons why they couldn’t possibly start investing in property, so it’s really interesting. So many people, it seems they’ve got no time and that’s stopping them from investing in property but they will be able to tell you every single competitor on Master Chef. Or, they’ve got no money but oh my goodness I just managed to go down the shops and buy the new Stella McCartney range of clothing. All this sort of stuff and it’s really interesting, the way that I’m starting to get the feeling that there are a lot of people who, they like the idea of investing in property but their reasons for not doing it are sort of excuses they feel like they need to justify why they’re not doing it and I think really, once you no longer need to justify and just ready to go then you’re ready to go.
Kaz: Yeah to me it’s all about a question of commitment and priority so when someone says I don’t have time or I don’t have the knowledge or I don’t have the money, to me it’s all about it’s just not a priority in your life right now.
Den: Yeah and I think quite often they will say to me, Den when will I be ready, when will I be able to do this. And I’ve started saying to them you’ll know, you’ll know when. Because there’s never going to be the perfect time, there’s always going to be something, so I figure when the time is right they’ll know because suddenly they’ll say well, there’s never going to be the perfect time so I’ll do it now.
Kaz: Yeah, I think it becomes, for me it’s only became like, initially it was an interest and then it sparked and then it sort of fizzled away at the back of your mind until it almost gets to a point where you just, you want, you need to take action.
Den: You’ve got to do something
Kaz: And I think it’s okay for people to say, look I don’t have the time or the money or stuff but I think it’s a little bit of lying to yourself. And it’s okay if it’s not your priority right now but maybe just recognize that that’s what it is, it’s not that you don’t have enough money because we both know, we both work normal jobs, everyday jobs that it’s not about how much you earn it’s what you do with it.
Den: Hey Kaz, episode ten. Got any special announcements for us?
Kaz: Well I just want to, I think we should commemorate or at least acknowledge that here we are on episode ten of Everyday Property Investing and I think I’m pretty excited to say that we’ve got here.
Den: Oh, they said we’d never make it!
Kaz: Who did?
Den: I don’t know!
Kaz: We’ve had quite a good response and a lot of people sending us comments and encouragement and we just wanted to say special thank you to everyone listening and we hope that you’re getting something of value out of it, we’re certainly enjoying it and we’re learning and having fun and we just hope that it’s bringing you guys something as well.
Den: Yeah frankly I can’t believe the number of people who have downloaded our stuff so I think it’s just awesome.
Kaz and Den: Thank you everyone!
Kaz: And now, if you happen to be over in iTunes, do give us a rating in iTunes and leave a comment and that can help us boost up the amount of people who get to see the podcast
Den: Especially if it’s a nice rating and a great comment?
Kaz: Preferably, yes!
Kaz: So our feature segment today we’re going to be talking about banks and loans. And as we said in our intro that’s a hugely important topic when it comes to purchasing property. We’re going to look about, look at different types of loans that you can get. And one of the things we’ll be discussing is that how the different types of loan really do depend on the strategy that you’re using. We’re going to look at the costs of setting up a home loan and talk about various types of home loans and the pros and cons. So, Den, tell us, what are the costs of setting up a home loan?
Den: Alright, well there are quite a few costs and I think you’ve got to be really aware that just because something might have a great interest rate doesn’t mean that it’s going to be the cheapest loan, ok. So you need to look for setting up fees, some setting up fees for loans are free, others go all the way to $2,000 or $3,000 so it’s significant. You need to look at monthly fees, there might be fees that banks charge for valuations for example, if you want to loan against your current property or if you want to use equity, quite often banks will charge you to do those valuations. But some banks don’t, there may be all other sorts of fees that you need to consider. So overall, when you’re judging what a loan is going to do for you and the cost in a loan, you need to have a look at the overall picture and do a sample calculation of how much you’ll be paying per month on each loan rather than specifically looking at an interest rate.
Kaz: So Den, there’s also as I understand it and this is something that we’ve looked into and have in place that there are different types of loans but there’s also packages, if you are a property investor you can look at various loan packages as well, which is like enables you to have loans together in some sort of meaningful way?
Den: Yeah there are a couple of different setups you can do this. There’s some investment sort of loan packages, where you can have one loan that is essentially a loan that you run your personal dealings with or I might be called an offset loan or something like that. There are loans then where every transaction through that loan is a tax deduction but not the first one, there’s all this sort of stuff. You can also have packages where a bank will say if your loans total a certain amount of money you can have 0.5% off all their interest rates or you can have some other deal, and they might give you a free credit card or they might you give you something in with that as well. So I think my bank calls that a wealth package but I think there are quite a few different banks that will offer you something to bundle everything together and that generally it helps you with the setup and of course they keep all your business which is what they want to do.
Kaz: Yeah, and I think just in terms of like the costs of setting up a home loan it’s worth looking. If you’re going to be purchasing multiple properties, or hope to, I think it’s certainly worth looking at some of those packages because they do offer, itmight be just a blanket fee per year and you get a whole lot of services related to it. So in terms of costs of setting up a loan, if you’re going to do this a lot, the property investing thing, then it could be worth looking at those specific investment packages.
Den: But also I think if you’re looking at getting a loan, don’t feel as though you have to go with the bank you’re already with. You know you’re the consumer you have the right of choice.
Kaz: Absolutely that’s a massive one. I would never just use a loan because it’s the bank I went to.
Den: Yeah exactly, exactly. Alright, now there are two basic categories of loans. There’s Principal and Interest and Interest Only. So Kaz, tell us what you know about Principal and Interest loans?
Kaz: Well Principal and Interest loan, and I’ll just preface all of this by saying I’m not a mortgage broker and I’m not an accountant, so this is just my everyday person understanding and obviously we recommend that you speak to a professional about this sort of stuff. But Principal and Interest loans are generally probably the most common type of loan. And it’s that sort of loan that the repayments you are making are paying not only the interest but the actual balance of the loan off. And this is great because it reduces the principal over time and so you’re basically decreasing your loan-to-value ratio steadily over time and owning more of that property. And the disadvantage with that though is that it’s usually a higher initial minimal repayment so you need to be able to afford that repayment to do it. Principal and Interest loans are really good for those who are looking to buy and hold, or have a bit more money they can put into their property or have a limited time frame available to pay off because you need to pay that loan down.
Den: Yeah. I know there are some people who will use a Principal and Interest loan as a strategy and I know the fifteen years strategy it is. And what they do is they’ll say, I need to get a property that will cover itself or that will be positive cashflow on a fifteen year long Principal and Interest loan, which means after fifteen years they own the property 100% because they’ve paid off the property and all the interest and then they earn that money now that’s coming in from that property. So they give themselves a fifteen year rule. If you bought a property using another sort of loan, an Interest Only loan, then after that fifteen years you still owe the entire amount of property, so you would be increasing your repayments by taking a Principal and Interest loan. But if there’s a way you can do that then by the end of the time frame, and in this case it’s a fifteen year time frame, you own the property outright.
Kaz: And so just for the Principal and Interest loan, I think one of the things that came into my mind was that for my own home, which is a non-tax deductible debt, it’s a personal debt, I sort of always make sure that I’m paying down that principal because it’s really important to me, at the moment we haven’t paid off our home completely and so I want to make sure I’m reducing the principal there because that is a debt that costs me money.
Den: Yeah there’s a really valid strategy of debt reduction and what you want to do is you want to reduce as much debt as possible, and the first debt that you reduce is your own personal debt.
Kaz: Yeah absolutely.
Den: Alright, now Interest Only loans. Interest will eventually be charged. There will be a point in time normally when an Interest Only loan will click over to Principal and Interest. But quite often what you’ll find is there’s a large amount of time when you’re paying interest only on a loan. Now the advantage of this is that you don’t have to pay any more than the interest repayments so you have lower repayments. And as another advantage, the principal itself although it stays the same number, because money devalues overtime with inflation, you actually owe less money in real terms during the length of that loan but it never gets down to zero in a way Principal and Interest does. The disadvantage of this is that there does become a time when you need to start paying off the principal of the loan. Now it’s a great sort of a loan for those who are looking to buy and hold and want the minimum repayments possible. So that keeps a maximum level of cashflow for them. And secondly, if you eventually sell, what you can quite often do is hold the property or hold this loan, have the property, sell the property for much more and not have to pay the full amount off because you’ve sold the property and you make the balance of difference.
Kaz: Yeah, in a way that we, just as an example of how we use the Interest Only loans versus a Principal and Interest is that we have our own home that we live in and that’s a Principal and Interest loan and we’ll have the Interest Only loans on our investment properties, because we want to have every bit of extra money that we have, we want to be servicing our own home loan.
Den: And reducing your personal debt.
Kaz: So absolute minimum repayments off from those investment loans and using all our excess cash to be paying down our own loan.
Den: Yeah absolutely. And the other important thing to keep in mind is quite often with both of these loans you have a facility where you can pay more money into the loan so you can reduce your debt faster. So you can also quite often re-draw and bring it back to the limit but if you’re doing that then just because you have an Interest Only loan doesn’t mean you can’t reduce the amount of money you owe on that loan and therefore reduce future interest payments, okay. The third one is a Line of Credit. A Line of Credit is a little bit like a credit card, okay, but it’s an Interest Only sort of a loan. Now it gives you loan repayments so therefore because it’s like an Interest Only loan the principal does reduce in real terms with inflation. But the danger of a Line of Credit is that you need to be good with your money. Because if you keep drawing it back up to the limit with things that aren’t good debt, then you end up having to pay a lot of interest and you start messing the account into an account that can be good debt and bad debt, and so you need to be really, really careful. And so a Line of Credit is fantastic for someone who is good with money and is really disciplined, then one thing they can do if they are disciplined enough and if they use the Line of Credit really well, they might find that they’ve paid enough down that they can use the gap of what they’ve already paid off for their next deposit.
Kaz: And this is an example of one of those sorts of accounts isn’t it where you pretty much pay everything you get, like all your pay, your monthly pay or whatever goes into that account. Your bills get paid directly out of that account, so it’s all like everything that you’ve got sitting around is sitting in there.
Den: It’s almost like an everything wrapped into one account that is a mortgage, well has the advantages of a mortgage and has the advantages of a savings account as well.
Kaz: Yeah as you said, I think you’ve got to be pretty, understand what your money is doing and where it’s going because you can get yourself into trouble by, you’ve got money sitting there you can draw upon and if it’s for the wrong reasons you might end up with more debt than you thought.
Den: Exactly, it’s all about discipline.
Den: Yeah, any others that you can think of Kaz?
Kaz: The Offset Account is the other one I was thinking about.
Den: Tell us about the Offset Accounts
Kaz: We’ve actually got one of these against our home loan. And it’s similar to a Line of Credit because you basically have, it’s a separate account though rather than being the same account so we’ve got our mortgage and then we’ve got this account which is like our everyday savings account, and our money gets paid into there and paid out the bills and all that sort of stuff. We use that as our everyday transaction type of account but the money that is sitting there offsets against the mortgage, so it has that same impact I guess as a Line of Credit but it’s a little bit not as combined, not as tightly bound I suppose, it’s an IT term I’m sorry, for the geeks out there. Yeah, so Offset Accounts, if your mortgage facility does not have, if it’s not a Line of Credit and it doesn’t have an Offset Account, then you are missing out, that’s how I feel. Like if you’ve got ten grand in your everyday transaction account and it’s not offsetting your mortgage then you need to go and have a talk to someone, that’s my view.
Den: Then you’re paying interests on ten grand more than you need to.
Kaz: Exactly and there’s a quick tip, if ever I’ve heard one, if you don’t have an Offset and you don’t have a Line of Credit, go and talk to someone at least about the Offset.
Den: Yeah absolutely, ok. Now the other thing is interest rates, you’ve got fixed rates and variable rates. Now can you tell me why would I want to fix interest rates?
Kaz: Yeah this is the age old question isn’t it and everybody’s trying to hedge their bets against which way rates are going. Fixed interest rates are good because it’s easier to budget because you will know what your payments will be, obviously with the variable, your repayments can go up and down and if you’re sort of on the edge of being able to afford something that can be quite dangerous so having a fixed rate is good in terms of budgeting because you know what the rates are going to be. But the downside is also that the fixed rate can often be a little bit higher than the variable rate when you set it up and the other thing can be that a lot of people can get really caught out with fixed rates where they’re fixed and then the rates turn and they’re stuck in this mortgage paying 10% when the rates have gone down to seven or something.
Den: I’m a little bit of a fan of variable rates, I have to say, and one of the reasons is that a couple of years ago when we had interest rates plummet with the global financial crisis, I was really struggling to see how I was going to make my repayments if interest rates kept going up. And I’ve actually written a blog about this but what happened is I ended up being able to increase one of my rents to withstand one more interest rate rise and then had it gone up again I probably would have gone and fixed one of my loans, but in the time that I bought, we had the crisis and interest rates plummeted and so rather than ending up in a position where I’ve fixed one of my loans at possibly 10% for a considerable amount of time I was suddenly found myself paying half of that with the variable rates. And the big appeal for me with the variable rates is so often you see variable rates offer a lower rate of interest.
Kaz: It’s such and it really is guesswork I think when you’re fixing rates and I know a friend of mine who, they had quite a big mortgage and they fixed it for a good five years or something like this and rates dropped significantly and these guys were forking out huge amounts of money and the fees to get out of that fixed loan were like, $16,000 to $20,000 of fees to get out of it, and they just they couldn’t do it so it really is a bit of guessing game and whether you want to fix or not is a real, it’s one of those things where property experts can’t tell you the answer to that.
Den: No, exactly, and I think we all have our own leanings one way or another. Now it’s also worth noting that quite often with mortgages you can fix a certain percentage and you can take a certain percentage as variable but
Kaz: That’s hedging your bets!
Den: as Kaz says that changing that combination or changing from fixed to variable can quite often be an expensive process and it’s one that in a way you want to avoid unless there’s a really good reason to do so.
Kaz: I remember when I went to see a mortgage adviser once several years ago and they showed me a document, now obviously I don’t know what that document was now, or how valid it was but it was looking at interest rates overtime and it was like a comparison of, if you had fixed rates or you had variable rates and they were pretty much saying that you’re pretty much always better off with variable rates, now I don’t know that that’s true but it always kind of stuck in my mind then I tend to also when I’m purchasing a property I factor in higher rates than what there are anyways so I’ve got my buffer in there, so I tend to use variable, I actually don’t have any fixed rates but obviously it’s a personal decision and something you need to talk about and think about yourself.
Den: And you’ve got to be comfortable with.
Kaz: Absolutely you need to sleep at night. So Den we’ve talked a little bit about different types of loans that are available and the pros and cons of those, where do we go, who do we talk to, to work out what loan?
Den: Well I think one person that I have a lot of confidence in, is my accountant. Now generally you can expect that advice from an accountant isn’t free, but if you’re going to make a lot of money out of this stuff you’ve got to be prepared to pay and I’m a big believer in paying for good advice. So I’d go to your accountant, you could also go to a mortgage broker but remember a mortgage broker is quite often there to offer you a product and isn’t a trained, necessarily a trained financial adviser. Obviously a financial adviser or a financial planner is someone else that can help you, or even have a chat to other people that invest in property especially those that have got a similar mindset to you and ask them what they do and why they do it. That may give you a fair education. But we’re both believers in a variable interest rate that’s generally the way we go, but we’re not the experts we’re not trained to give financial advice so you’re better off checking your own field of experts.
Kaz: And the other thing, another tip I would give there is to shop around, because there’s no loyalty when it comes to, or there needs to be no loyalty when it comes to choosing the right bank for the right loan and they will vary and the money that you can save with the right loan is well worth the effort of actually shopping around and negotiating something, a deal.
Den: Absolutely, absolutely.
Den: Now this episode’s Quick Tip is a quick calculation that might help you work out how much interest rates can affect what you pay on your loans. So it’s worth keeping in mind that every 1% difference in an interest rate means about $80 per month difference on a $100,000 loan. So if you keep that in mind then when banks are looking at charging you monthly fees or other fees you can start considering that if their interest rates are maybe half of percent lower but they charge you $40 a month you’re paying about the same. So it’s 1% difference in interest rate means about $80 per month for every $100,000.
Kaz: I’ve got another quick tip to add there Den, that I wanted to mention and that’s just when you’re looking to do your repayments in your loan is to try and factor in the fortnightly repayments if you can because you end up getting that extra repayment in, that’s always an oldie but a goody, if you can, your fortnightly repayments will mean that it puts you a little bit ahead.
Den: So what you mean there is get your monthly repayment and halve it and pay that every fortnight.
Den: Hey Kaz! So what’s this week’s action?
Kaz: Oh we’ve got a couple of little actions for you. Number one, find yourself a mortgage broker, who deals with property investment to help you assess loans and find the right deal and that should be a free exercise. Mortgage brokers are great, as we said before they’re not the person at the end of the day who’s qualified to give you financial advice but they can be very helpful in helping you assess a wider range of loan packages and work out which one maybe the best for you and they do that for free which is great, particularly though make sure that the one that you will deal with understands and knows about property investment and you can find companies who deal specifically with property investors because that’s a different business to the your single home buyer type situation.
Den: Yeah and I’m pretty sure also that mortgage brokers have to disclose any kickbacks they get or any commissions they get as well.
Kaz: Yeah and a lot of them especially who work with some companies they get the same commission regardless
Kaz: of what product they sell you so it’s in their best interest to sell you the best product rather than to sell you a particular product. So find yourself a mortgage broker who deals with property investment and get them to help you assess the loans and then make your decisions with professional advice. So go and see your accountant and make sure that what you’re proposing to do in conjunction with your mortgage broker is the thing that is financially best for you based on expert opinion there.
Den: Yeah and with the accountant, as I said before it might cost you a couple of $100 to talk to your accountant…
Kaz: Money well spent…
Den: Great money well spent! If you consider that this could be something that you’ve got for 25 years and the wrong decision could cost you thousands.
Den: This week’s email is from a listener in California in the US. Aaron writes, ‘what do you guys think about buying these turn-key investment properties from’, and he mentions one of the companies that offers these deals. ‘5K deals, really? I’m afraid it could be a scam what kinds of things should we stay away from?’ Kaz, what’s your response?
Kaz: Well turn-key investment properties from various companies, I mean we have a lot of that here as well as I imagine the States has it and I imagine everywhere does. My feeling is that I’m always wary, and we’ve talked about this before on the podcast, about people selling me property investing by selling me their projects or their houses or their property. I think there’s a bit of a conflict of interest. And I’ve certainly heard of a lot of scams and a lot of people who’ve been burnt by being sold properties by companies claiming to sell you property investing.
Den: Yeah I think I start wondering, well look are you selling me investing knowledge or are you selling me a house because there’s one or the another but I don’t know if you can really do both together.
Kaz: Yeah and I think the main thing is that the numbers have to stack up and that’s your numbers not their numbers. Companies like this will often give you a very well-rehearsed speech and a very well-presented spreadsheet of numbers but it’s your numbers that count. So if I were looking at any company like that, I’d make sure that I would listen to everything they had to say, of course and look the information they’ve provided, but Id take everything with a grain of salt and I would be doing a whole lot of due diligence and running all of the numbers through my own systems to make sure that things stack up. Companies like that can often have figures that are ambiguous or just ambitious they can factor in capital growth over development time and things like that. Often they can sell you properties that are in areas where there is an over supply of townhouses for example, and you end up at the end with an asset that was worth less than what you actually borrowed to get it in the first place. So I think you’ve got to be very, very careful is my answer to this. When people offer things like no money down or very small money down, Aaron mentions ‘5K deals really, is that true?’ My view of that is that people will be recovering their costs somewhere in the project so you’ve got to look out for that so no money down doesn’t necessarily mean no money down it just means money down somewhere else that you didn’t know about.
Den: Yeah, no, that’s fair enough. I think although I’m getting the feeling that you’ve got your reservations, it’s important to say not everyone that offers these things are crooks, not everyone is an issue. You might get great deals this way, just make sure you do your due diligence. Do your numbers take responsibility for your investments and don’t necessarily get sucked in.
Kaz: Yeah I agree, you’re right, there are a lot of good companies out there who offer this sort of thing and a lot of people who’ve been successful from investing in these sorts of things, but like you said we advocate doing your homework on the company, on their reputation, on the deal, the specific deal that you’re looking at and the finances that they’re talking about and make sure that you are really happy before you lay out your hard-earned dollars.
Den: Well thanks for that question Aaron. Now just a reminder if you’ve got a question or comments or if there’s something you’d like to know please do feel free to contact us. Our email address is email@example.com. We’d love to hear from you.
Den: Well that about wraps it up for this episode and we’re looking at the holiday period. Now this may not be the last episode before the holidays because we’re looking at releasing another podcast that’s an interview, and it’s an interview of someone you know Kaz, who is that?
Kaz: That’s right, I’ve got an interview with Noel, who is an accountant, Noel May from Noel May and Associates, and he’s a very knowledgeable guy in terms of accounting and investing and a very entertaining guy as well. So I’m hoping that we could bring you a fun interview over the holiday.
Den: Okay so it should be a little bit of a smile a little bit of information. Now as always you can email us with any comments or suggestions or questions at firstname.lastname@example.org. In our new year we’ll have all the usual segments news and tips make sure though you get over to iTunes and subscribe to our podcasts, until then.
Kaz: Until then.
You’ve been listening to Everyday Property Investing, the show empowering everyday people to create wealth and achieve financial freedom. Please note that this show provides general advice based on personal experiences and is for educational purposes only. We’re not qualified accountants or lawyers or licensed to provide professional financial advice for you. We strongly advise that you employ the services of qualified professionals and seek their advice that is specific to your own personal circumstances. You can visit us at www.everydaypropertyinvesting.com. See you next time!