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
- 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%.
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.
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.