Can you afford an investment property deposit?

Buying an investment property may require an upfront deposit of 20 per cent of the property’s value. If you haven’t saved up enough cash to afford a deposit, there may be other options available to help you invest in property.

Mortgage lenders prefer that borrowers can afford an upfront deposit of at least 20 per cent of a property’s value when making a home loan application, as this helps to minimise the lender’s financial risk if the borrower was to default on their repayments. Generally, the higher your deposit, the lower the lender’s risk, and the more likely you are to be approved for a home loan with lower interest rates and/or extra features and benefits.

Lenders also often consider investors as riskier to lend to than owner occupiers, who are seen as more likely to keep up with their repayments to keep a roof over their head. This means lenders may charge higher interest rates and fees and/or require borrowers to fulfil additional eligibility criteria to qualify for these loans.

If you can’t afford to pay a 20 per cent deposit on an investment property, some of the options you could consider instead include: 

Buying with a smaller deposit

Some lenders will accept a smaller deposit of 10 or even 5 per cent of a property’s value when you’re applying for an investment loan, so you can spend less time saving and make your purchase sooner.

However, a deposit of less than 20 per cent means you’ll likely be charged Lenders Mortgage Insurance (LMI) when you make your application. This insurance policy covers the lender (and not you, the borrower) against the risk that you could default on your repayments.

Lenders usually pass the cost of LMI on to borrowers, and the lower your deposit, the more you may be charged for LMI. This could affect your investment budget, so be sure to calculate your potential LMI charges before making an application.

Also, most lenders will want a minimum amount of your deposit to be made up of “genuine savings”, which is income earned from your job. It may be harder to successfully apply for an investment mortgage if your deposit comes from a gift, inheritance, or income from other sources. 

Using your equity

If you already own a property (your first home, for example) you may be able to use your equity in that property in place of a deposit on an investment property.

Your equity is how much of a property’s value that you own outright, and doesn’t have a mortgage owing on it. You can find your current equity by taking your property’s current value and subtracting how much is still owing on your mortgage.

For example, if you own a house that’s currently valued at $1 million, and still owe $700,000 on the mortgage, you have $300,000 equity in the property. 

You can use the equity in your home in place of a deposit when applying for a loan to buy an investment property. However, you may not be able to use all of your equity for this purpose as your current lender will want you to keep a minimum amount of your home’s value “unencumbered” by a mortgage to maintain their required Loan To Value Ratio (LVR). You can find your usable equity by subtracting the amount owing on your mortgage from 80 per cent of your property’s current value.

Following on from the previous example, 80 per cent of your home’s value would be $800,000. Subtracting the $700,000 still owing on your mortgage would leave you with $100,000 in usable equity. 

By using your usable equity in place of a traditional 20 per cent deposit, you may be able to apply for a mortgage to buy an investment property valued at up to five times your usable equity. That said, NAB suggests limiting yourself to a property valued at four times your usable equity, as this would allow you to more easily capitalise your upfront expenses, such as stamp duty, into the loan.

So, with $100,000 in usable equity, you may be able to invest in property valued up to $500,000. But if you also want to capitalise your upfront expenses, you may want to look at properties valued up to $400,000 instead.

Get help from a guarantor

If your saved deposit and/or your equity won’t be enough to cover the deposit required for the deposit you want, you may be able to get help from a guarantor to avoid being charged for LMI. This is where a close family member (typically a parent) “guarantees” your loan application using the value of their own property. If you default on your repayments, your guarantor would become responsible for your loans.

Applying with a guarantor may not be an option for every borrower, as the guarantor would need to hold sufficient usable equity in their own property and fulfil the lender’s other eligibility criteria. It also puts the guarantor’s property, credit score and financial situation at risk, so it’s important that all parties are aware of exactly what’s involved before signing on any dotted lines.

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