Investing - Home Loan Guy

Property investing can be a fantastic way to build wealth. From 1996 to 2020, Australia’s median house price jumped an astonishing 415%, from $160,000 to $825,000, according to the Real Estate Institute of Australia.

But how do you get started? And then, once you do get started, how do you build a life-changing property portfolio?

Australian Taxation Office stats show that only 15.5% of taxpayers are property investors. And of those who are, 71.2% have just one investment property while 90.2% have just one or two.

In other words, most people don’t know how to get started; and those who do find it hard to keep going.

To succeed with property investment, you need to get a lot of things right, including what to buy, when to buy it and how to structure your loans. That’s why it’s so important to get expert advice from an experienced mortgage broker.

Together, we’ll discuss your long-term goals, so you know where you’re going.

We’ll also crunch the numbers for your first (or next) investment property, so you can understand what sort of property you can afford and how much you can borrow.

Planning is key, because rushed decisions are often poor decisions.

MAKE AN APPOINTMENT

Are you ready to buy an investment property?

To know whether you’re ready to buy your first (or next) investment property, there are four key things we need to
understand:

1. Borrowing power

How much money will the bank lend you?

2. Capacity

How much debt are you comfortable carrying?

3. Deposit & equity

How much money do you need to contribute? How much equity can you access?

4. Purchasing power

How much money can you pay for the investment property?

Let’s go through these elements one at a time. By the end, you’ll have a much better understanding of whether you’re
ready to buy an investment property.

Borrowing Power

Contribution

CAPACITY

Purchasing Power

Your borrowing power will be based on two factors:

Your current income
Your future rental income from the investment property

We’ll also need to consider your current financial obligations, such as rent, mortgage repayments, other loans, credit cards, HECS debts and any other liabilities you might have.

You might be surprised to learn that your borrowing power can vary significantly from lender to lender: Bank A might be prepared to lend you $50,000 or $100,000 more than Bank B. Naturally, the amount you can borrow will play a major role in what investment property you can afford to buy.

I will work with you to understand your real borrowing power.

Want to get started on your property investment journey? Book an appointment.

2a. Deposit

Do you already own your own home? If so, you might be able to use equity from that home to fund the deposit on your investment property (see below).

If the investment property you’re planning to buy will be your first property, you will generally need a cash deposit. (Some lenders will let you use a family equity guarantee instead of a cash deposit.)

If you’re planning to put down a cash deposit, you need to get a feel for how large it needs to be. To understand that, you need to estimate the total cost of your property purchase – which will be the purchase price plus several other costs:

Stamp duty
Conveyancing
Additional costs (e.g. buyer’s agent fee, strata report)

As a rough guide, all those other costs will add up to about 5% of the value of the property you buy. So the total costs of buying the property will be about 105% of the purchase price.

For example, imagine you were buying a $500,000 property:

Purchase price $500,000
Other costs $25,000 (5% of purchase price)
Total purchase cost $525,000

Next, you need to ask yourself how much of that $525,000 will be contributed by you and how much by the bank.

Generally, banks will lend you up to 90% of the value of the property you’re buying (rather than 90% of the total purchase cost), which means you’d need to contribute the final 10% plus the 5% in other costs. In this scenario:

Bank contributes $450,000
You contribute $75,000

But there’s one complication. If you borrow more than 80% (as in this scenario, where you’re borrowing 90%), you’ll generally need to pay lender’s mortgage insurance – which, in this scenario, would cost about $10,000. Some lenders will add this insurance premium on to the loan, while others will make it part of the 90%.

Confusing, right?

Property investing would be much simpler if every lender had the same policies. But they all have different policies. An experienced broker understands these different policies, and so can steer you towards the lender that is most suited to your specific circumstances.

2b. Equity

If you already own your own home, you might not need a cash deposit; instead, you might be able to fund the deposit by borrowing against the equity of your home.

In simple terms, equity is the difference between how much your home is worth and how much you owe on the mortgage. However, when lenders calculate equity, they generally ‘give’ you only 80% of the property’s value. (Some lenders will allow you 90%, but then you’ll generally have to pay lender’s mortgage insurance.)

So if, hypothetically, your home was worth $800,000, lenders would ‘give’ you 80% of that, or $640,000. If your existing home loan balance was $515,000, your available equity would be $125,000.

Let’s continue with the hypothetical example we started above – where you expect to buy an investment property worth $500,000 and pay extra costs of $25,000 for a total cost of $525,000.

To avoid paying lender’s mortgage insurance, you’ll need to contribute 20% of the $500,000 purchase price, or $100,000. And you’ll need to pay for those $25,000 in extra costs. So, in total, you’ll need to contribute $125,000.

As we calculated earlier, you have $125,000 in available equity with your current property.

So you can turn that $125,000 of equity into a new $125,000 loan that you use to pay for the $125,000 you need to contribute towards buying your investment property.

Does it seem like a magical coincidence that the amount of available equity was exactly the same as the size of your contribution? Well, it wasn’t – because one of a broker’s tasks is to make sure all the numbers add up.

“Can I afford it?”

That’s the big question everyone asks themselves when they think about buying an investment property.

The affordability question has two parts. First, you need to ask if you can afford the one-off contribution needed to buy the property. Second, you need to ask if you have the capacity to make the ongoing mortgage repayments.

To understand if you can afford the ongoing mortgage repayments, you need to know what your ‘yield’ is likely to be – i.e. how much rental income you’ll get relative to the purchase price. And that can differ from location to location. For example, here’s the sort of yield you might get if you bought a property valued at $500,000:

Sydney = 3% ($288 per week in rent)
Brisbane = 5% ($481)
Regional area = 6% ($577)

You also need to look at tax deductions when calculating whether you can afford the ongoing mortgage repayments.

If you buy a new property, you’ll be able to make bigger deductions for depreciation (compared to buying an established property), which will mean you pay less tax and have stronger cashflow.

Please note, though, that these questions are more complex than they first appear. A property in Sydney with a 3% yield might be a better investment than a property in a regional area with a 6% yield, because it might deliver superior capital growth. And an established property with smaller deductions might be a better investment than a new property with larger deductions, because it might have a lower purchase price.

Whatever investment property you buy, you need to make sure you have the capacity to make the ongoing mortgage repayments. An experienced mortgage broker can help you with the calculations.

Want to compare the cashflow impact of different properties? Click here for a helpful tool.

Once we’ve analysed your borrowing power, deposit, equity and capacity, we move on to the final piece of the puzzle – purchasing power.

This is the maximum amount of money you can spend on an investment property.

Once we’ve calculated your purchasing power, I’ll be able to find you a lender and loan product that best suits your circumstances, and you’ll be able to start looking for your property.

Lender selection

Wondering which is the best lender for property investors?

Well, there’s no one ‘best’ lender. It differs from person to person, depending on their personal situation.

The best lender for a young, single contractor is likely to be different from the best lender for a middle-aged couple with well-paying PAYG jobs. And the best loan product is also likely to be different.

So when we sit down together, I’ll need to get a detailed understanding of your financial position, your long-term goals and the type of property you want to buy. Then, I’ll organise a pre-approval for you that will tick these four boxes:

The right lender
The right loan structure
The right interest rate type (variable or fixed)
The right repayment method (principal-and-interest or interest-only)

When I lodge the pre-approval, I’ll be pitching a specific scenario to the lender. For example, if we continue with our hypothetical scenario (buying an investment property valued at $500,000), here’s what I’d say to the lender when submitting the application:

The borrower has a total purchase cost of $525,000:
- $500,000 for the home
- $25,000 for other
The borrower plans to borrow $400,000
The borrower’s contribution will be $125,000 (a loan against the equity in their existing property)
The loan will be a three-year fixed loan with interest-only repayments
The borrower has payslips to verify their income
The property will rent for an estimated $288 per week

To give ourselves the best chance of getting your loan approved, we need to follow the lender’s rules. Different lenders have different policies, which means your scenario might need to be pitched in different ways to different lenders. I’m an experienced broker, so I understand what documentation each lender requires and best way to present it.

Ready to start planning your investment property purchase? Book an appointment.

MAKE AN APPOINTMENT

PROPERTY INVESTMENT TIPS

How do I find the best investment property?

There are three options to choose from:

Do your own research and buy your own property
Outsource the research and buying to a buyer’s agent
Outsource the research and buying to a property research company

Doing your own research and buying your own property

This is the free option – although it might cost you down the track if you don’t have the expertise to buy the right property in the right location. You can access suburb reports and individual property reports. (If you don’t know where to find them, contact me at David@thehomeloanguy.com.au and I’ll tell you.) You can also consult the Month in Review report published by valuation firm Herron Todd White.

Outsource the research and buying to a buyer’s agent

You engage the buyer’s agent to find and buy the property on your behalf. They will have access to in-depth research, to help you pick the right location. They will also have experience in inspecting properties and negotiating with agents, to help you buy the right property at the right price. They may charge you a flat fee (e.g. $10,000) or a percentage of the property purchase price (e.g. 2.2%).

Outsource the research and buying to a property research company

Like a buyer’s agent, a property research company will do the research and buying on your behalf. The big difference is you don’t pay a fee, because they receive a commission from the vendor or developer. The best property research companies are skilful, ethical businesses that will use a robust selection process to find you quality properties that are likely to outperform the market over the long-term. However, some disreputable outfits may place their commission ahead of your interests.

Should you buy a house or unit or townhouse?

Houses might increase in value faster than units or townhouses, offering more potential for long-term capital gain. However, houses generally require more maintenance and attract higher insurance premiums. Also, they might be harder to find tenants for.

Units and townhouses are likely to require less maintenance than houses and attract lower insurance premiums. Also, they might be more attractive to tenants. However, they might not increase in value as quickly. Also, you’ll probably have to pay quarterly strata levies.

Want to compare the cashflow impact of different properties? Click here for a helpful tool.

Treat your purchase as a business decision

Investment decisions should be made with your head, not your heart. You buy an investment property to make money, not to live in, so you need to approach it as a business transaction.

As a general rule, you should look for a property that is well-presented, rather than luxurious. It’s generally a good sign if the property has a neutral interior colour scheme, serviceable and resilient flooring and window coverings, a low-maintenance yard and good storage. If you’re buying an older-style unit, it’s generally good if it has few stairs, an internal laundry and a garage or car space.

The more of those boxes you tick, the more attractive tenants will find the property … which, in turn, means you’ll find it easier to rent out and you’ll increase your returns.

Conversely, if you struggle to attract tenants, and the tenants you do find move out every six months, you’ll earn less rental income and pay more in letting fees.

Try to buy a property in a desirable location

Why is ‘location, location, location’ so important? Because the more desirably located your investment property is, the easier you’ll find it to attract tenants and raise rents.

Tenants tend to value convenience, so properties near restaurants, shopping centres and public transport may be good investments.

That said, different tenants value different things – a young single (who might want a small apartment) will have different tastes to a middle-aged family (who might want a larger house with a backyard and pool). So they will also have different opinions about what constitutes a desirable location.

So make sure you do your research before you buy. Look at past, present and expected future results for property prices, rental rates and vacancy rates. Investigate if any new developments are in the pipeline and if any new infrastructure has been planned or predicted. Also, walk around the area so you can get a tenant’s perspective.

Price is important. But it’s just one of many factors you should weigh up when researching investment properties.

What is positively geared and negatively geared? And which is better?

Property investment is a business. As with any business, there will be money coming in (rent) and money going out (mortgage interest payments, property management fees, maintenance, insurance, council rates and other costs). The balance between the incomings and outgoings is known as gearing:

A positively geared property = the money coming in exceeds the money going out
A negatively geared property = the money coming in is less than the money going out
A neutrally geared property = the money coming in matches the money going out

Some investors like to do their gearing calculations before tax. Others like to do their calculations after tax (which can be more favourable if you receive tax deductions for interest payments and depreciation).

There’s a common view that it’s good to have a negatively geared investment property, because it means you can use the losses to reduce your taxable income. However, be warned – a negatively geared property will cost you more to hold than a positively geared property. So that means you’ll have less spare cash to fund your day-to-day expenses and
pay your mortgage.

Want to compare the cashflow impact and gearing status of different properties? Click here for a helpful tool.

How property investors can use depreciation to pay less tax

If the project goes over budget, you will need to find a way to cover the extra costs – normally through extra savings. In other words, don’t expect the bank to just increase the amount of your original construction loan. If you watch grand designs, it is the constant changing of the plans that adds to the cost. In Australia we call this variation. Variations before you start are fine, so consider all the options. One the build is underway variations can be expensive.

Property is different to other investment classes like shares, because you can claim depreciation as a tax deduction.

Depreciation is the decrease in value of the home and the fixed items inside. For example, a hot water heater that an investor bought five years ago would be worth less today than on the day it was purchased. The difference between those two values is the depreciation – and the investor can use that depreciation to reduce their taxable income.

But how do you know the rate at which your hot water heater, and other assets, is depreciating? Well, different assets depreciate at different rates, according to official ATO formulas. New investment properties also have more depreciation than established properties.

That’s why it can be a good idea to get professional help, from a quantity surveyor and accountant. For a fee (around $600-800), a quantity surveyor will assess your investment property and complete a tax depreciation schedule. You then give this to your accountant, who will incorporate it into your personal tax return.

Want to read a helpful case study about depreciation? Click here.

Should you buy a new property or an established property?

The pros of buying a new investment property are that the home will probably be in better condition (compared to an established property) and you’ll be able to claim more depreciation. The cons are that off-the-plan properties and house-and-land packages may be overpriced (because there are more middlemen involved) and enjoy less capital growth (because there are many other similar homes out there).

The pros of buying an established investment property are that you might pay a lower price and enjoy more capital growth. The cons are that the home might be in worse condition and provide fewer depreciation benefits.

Property investors receive both yield and capital gain

The yield is how much rental income you collect as a share of the purchase price. For example, if you buy a $500,000 investment property that delivers you $15,000 rent per year (or $288 per week), your yield would be 3% (because $15,000 is 3% of $500,000).

The yield calculation described above is ‘gross yield’ – annual rent as a share of the purchase price. But there’s also a thing called ‘net yield’, which is annual rent as a share of the purchase price PLUS all other costs (stamp duty, mortgage repayments and other costs).

Capital gain is the amount by which the property’s value increases over time. This can be expressed as a number or percentage. For example, if your $500,000 property grows in value to $600,000, your capital gain will be $100,000 or 20%.

Often, investors have to make a trade-off between yield and capital gain. For example, a Sydney property might average an annual yield of 3% and capital gain of 7%. Conversely, a regional property might deliver a 6% yield but only 0.5% capital gain.

Want to compare the different yields of different properties? Click here for a helpful tool.

Is it better to get an interest-only or principal-and-interest loan?

There’s no one answer to this question, because it depends on each investor’s personal circumstances. For some investors, an interest-only loan will be most suitable; for others, a principal-and-interest loan.

Interest-only loans have two main pros. First, you reduce your mortgage payments, at least temporarily (because instead of paying principal AND interest, you pay just interest). Second, 100% of your mortgage payments are likely to be tax-deductible (because interest payments are tax-deductible, but principal repayments are not). However, interest-only loans have one main con – you pay more over the life of the loan compared to principal-and-interest.

The positive of going principal-and-interest is you pay less over the life of the loan. The negative is you may get fewer tax benefits.

All this talk of tax leads on to the issue of good debt versus bad debt. Here’s the difference:

Good debt = debt that delivers a tax benefit (e.g. investment loan)
Bad debt – debt that is not tax-deductible (e.g. owner-occupied loan, car loan, personal loan, credit card)

As a general rule, it’s best to pay off your bad debts first. So if you have an owner-occupied loan (which isn’t tax-deductible) and an investment loan (which is), it’s generally best to pay off the former before the latter.

That’s why it can be smart to set your owner-occupied loan to principal-and-interest and your investment loan to interest-only. The idea is that the money you would have spent on paying down your investment principal can be used to pay down your owner-occupied principal instead. So you pay off your bad debt at the expense of your good debt.

The great thing about paying off the debt on your home while you’re working is you have options in retirement. You’re not forced to downsize so you can clear the debt. Instead, you can stay in your home if you wish … or downsize if you wish. You can keep your investment property if you wish … or sell it if you wish.

FREQUENTLY ASKED QUESTIONS

How much money can I borrow?

There’s no one answer to this question, because borrowing power differs from person to person, depending on your personal financial position. Book an appointment with me if you want to know your borrowing power.

How do I choose the best loan?

To choose the best loan, you need to compare your personal financial position with all the available loans in the market, and then pick the one that is most suitable to you. That’s hard to do, because it can be surprisingly hard to understand your own personal situation (yes, even though it’s your situation). And, of course, it’s hard for someone who isn’t a broker to understand all the available loans in the market. Book an appointment with me and I’ll help you find a great loan for your situation.

How much do I need for a deposit?

As a general rule, you need to contribute at least 15% of the purchase value of the property (i.e. $75,000 on a $500,000 purchase). Depending on your circumstances, you might be able to make a smaller contribution, or make the contribution by borrowing against the equity in your home (rather than paying cash). Book an appointment with me to discuss your options.

How often do I have to make home loan repayments?

Most lenders will let you make weekly, fortnightly or monthly payments. If you choose an interest-only loan, the lender will generally calculate the interest on a monthly basis, which is why many investors opt for monthly repayments.