Borrowing to buy an investment property for most of us is the norm – rarely does someone have enough money saved to buy the property outright, and even if they did our advice would be not to do so.
In fact recent Australian Bureau of Statistic figures put property investment lending at over $10 billion.
So when you’re ready to create long-term wealth through investment vehicles such as property, what are some of the issues you should consider and look out for?
Here are our top six tips to better borrowing for your investment property.
1. Understand your borrowing capacity vs your purchasing capacity
In a lot of circumstances, your capacity to purchase a property is generally much lower than what your bank has advised they will lend, usually because the difference hasn't been explained and they are two very different things.
For example to buy a property for $500,000 at an 80% loan to value ratio (LVR), you need to contribute a $100,000 deposit either from cash or borrowed from other equity (your own home or another property), plus your purchasing costs (legals, stamp duty etc.) of around 5%. So in effect you would need around $125,000 as a deposit.
While you may have a borrowing capacity of $500,000, your purchasing capacity would be around $375,000 assuming the banks valuation comes in at the purchase price amount.
Make sure you understand the difference between borrowing and purchasing capacity before you start looking at investment properties and where your deposit might come from.
2. Know what equity you might have
Investors may not realise how banks calculate equity. If your home is worth $500,000 and you owe $300,000, then you may think they have $200,000 equity.
How the lender actually calculates your equity is by the value of the property as assessed by your valuer, less the average 80% LVR then less the debt.
So if the value is $500,000, then 80% is $400,000 less the $300,000 debt, which is really $100,000 (not the $200,000 they were expecting).
It’s important to know exactly what equity you have so you can estimate your purchasing capacity.
3. Borrowing 100% plus costs
If you are unsure about how you can borrow 100% plus all costs without putting in your own cash.
The lenders will generally lend on residential property, between 80% to 90% of the value, secured against the new investment property.
The other 10% to 20%, plus around 5% for purchasing costs, can be borrowed from other equity. If you have another property you may be able to borrow against any equity you have in it and use this as the deposit.
This way you can borrow 100% of the purchase price plus costs, but remember it’s secured across two separate loans.
4. Lenders mortgage insurance
When banks lend above 80% of the value of a property they will require lenders mortgage insurance (LMI). This can make the borrowing criteria a little tougher as you need to satisfy the bank and the mortgage insurer.
However astute investors will often see LMI as an opportunity because for a few thousand (tax deductible) dollars they can preserve their equity and use it to leverage into another investment.
If that extra investment was for a $300,000 property and it grew by 9% each year, it would mean they increased their equity by $27,000 in year one alone. So their investment requiring LMI would definitely be worthwhile.
In most cases the Australian Taxation Office will refund you the LMI premium as a deduction.
5. Use more than one lender
You may likely find that to build a property portfolio you will have to use more than one lender. The way lenders access your serviceability is to build in a buffer for their risk.
If you have a 6% interest only loan on an investment property for example, they may assess your serviceability based on 7% principal and interest, and only include 70% of the potential rent as a conservative measure.
When you look to purchase another investment property the lender will apply the same process again until you will reach a ceiling where the bank will likely tell you that you can’t borrow any more.
However if you go to another bank they will generally access your serviceability based on what you are actually paying without inflating the costs, as its new business to them and often you can get the funds you need to proceed to purchase your next investment property.
6. Separate personal and investment funds
It is very important to understand that you should keep personal funds and investment funds totally separate.
If you have a line of credit for example which you use for investment purposes and you claim the interest as a tax deduction, do not take anything from that account for personal use or you may endanger the tax deductibility of the interest.
Looking at borrowing for an investment property and need some advice or someone to point you in the right direction? Give us a call today on (08) 8932 8858 and we can assist you.
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