2. Re-set your minimum cash reserve
Cash reserve is not a new concept to most property investors; most of us know we must have them to cover our rainy days.
How much is sufficient is quite a personal matter, but the general idea is: how many months you would like your cash reserve to last if you experience severe loss of income and overrun of cost at the same time.
• Loss of income can be loss of your job & business income, default of debtors, loss or decrease of investment income such as rent & dividends;
• Overrun of cost can be increase of interest repayment from your mortgage, unexpected expenses.
One thing worth mentioning is mortgage interest rates. We are around 5-6% at the moment; the average mortgage interest rate over the last 30 years is around 10%. So if you don’t fix your interest rates, you may want to add another 5% to your current interest rate to calculate your debt repayment.
Many property investors leave their cash reserve with their Line of Credit, because most the Lines of Credit offer the flexibility to not make any repayment as long as the limit has not been reached.
Line of Credit can potentially present a problem for you if the lender decided to freeze it due to a drop in your property value or simply lack of credit available. While this hasn’t quite happened in Australia, it has definitely happened in other countries such as the United States.
In such cases, you will lose your cash reserve overnight without warning, so the better alternative is a Redraw with an Offset account, and keep your cash reserves in the offset account.
The aim of a cash reserve is not to cover your cash flow short fall forever, but only temporarily. Hence the strength of your cash flow has a lot to do with the length of the coverage.
For example, if your cash flow is positive and very unlikely to be reduced, then you may want to consider a 6-month window for the worst-case scenario. But if your cash flow is negative or very likely to be discontinued, then you may need sufficient reserve to cover quite a number of years or at least to the point you can safely sell the property at a price greater than your mortgage.