Are you ready to buy an investment property?

Are you ready to buy an investment property?

Property investment is a popular wealth creation strategy in Australia, and it’s easy to see why. Houses and apartments can be easier to understand than the share market, not to mention less volatile, and a shortage of stock can guarantee a steady capital gains trajectory.

Before you take the plunge into property investing, however, you should ensure you are ready for it.

Make sure you can afford it

At least at the beginning, the rental income is unlikely to cover the mortgage repayments and other expenses that are part and parcel of maintaining a property, such as council and water rates. And like any property purchase, you will have to pay stamp duty, conveyance fees, legal charges, search fees, and pest and building reports.

In other words, your investment will be costing you money. Therefore before you buy an investment property, you must ensure you have enough cash flow to cover these expenses.

Financial adviser Greg Pride of Centric Wealth suggests working out if you are ready to buy an investment property by deducting your current expenses from you income. This will give you your savings capacity.

“If you don’t have a savings capacity, there’s no point getting started because you won’t be able to fund it,” Pride says.

Be prepared for stumbling blocks

One of the pitfalls of property investment is that there may be periods when you don’t have tenants and will have to cover the costs without the added benefit of rental income. Again, cash flow is important – ensure you have enough accessible cash to cover such down times.

And just because interest rates are currently at historical lows, it doesn’t mean they won’t rise again. When calculating whether you can afford the repayments on an investment, consider what you would have to pay at a higher interest rate, such as 8%.

Do your homework

Don’t assume that any property in any location will increase in price or provide strong rental returns. If you are not willing to research different areas and their rents and vacancy rates, then you are not ready to buy an investment property.

Well-located properties, close to amenities and desirable neighbourhoods, will increase in value. “But there are areas where you can lose money,” says property investment expert Michael Yardney, CEO of Metropole Property Strategists. “For example at Docklands in Melbourne, property prices have probably not increased in value at all in 10 years because of an oversupply.”

Be in it for the long haul

From having an adequate deposit to maintenance costs, property has high entry costs so the best way to reap the rewards is to adopt a long-term strategy.

According to Yardney, in every 10-year cycle there will be a couple of years of exceptional price growth and an equivalent period of price drops or stagnation. To come out on top, you should be prepared to hang onto your investment property for 10 years or more.

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Learn more about home loans

What is an investment loan?

An investment loan is a home loan that is taken out to purchase a property purely for investment purposes. This means that the purchaser will not be living in the property but will instead rent it out or simply retain it for purposes of capital growth.

Mortgage Calculator, Property Value

An estimate of how much your desired property is worth. 

What is bridging finance?

A loan of shorter duration taken to buy a new property before a borrower sells an existing property, usually taken to cover the financial gap that occurs while buying a new property without first selling an older one.

Usually, these loans have higher interest rates and a shorter repayment duration.

What is stamp duty?

Stamp duty is the tax that must be paid when purchasing a property in Australia.

It is calculated by the state government based on the selling price of the property. These charges may differ for first homebuyers. You can calculate the stamp duty for your property using our stamp duty calculator.

What is a line of credit?

A line of credit, also known as a home equity loan, is a type of mortgage that allows you to borrow money using the equity in your property.

Equity is the value of your property, less any outstanding debt against it. For example, if you have a $500,000 property and a $300,000 mortgage against the property, then you have $200,000 equity. This is the portion of the property that you actually own.

This type of loan is a flexible mortgage that allows you to draw on funds when you need them, similar to a credit card.

What is equity and home equity?

The percentage of a property effectively ‘owned’ by the borrower, equity is calculated by subtracting the amount currently owing on a mortgage from the property’s current value. As you pay back your mortgage’s principal, your home equity increases. Equity can be affected by changes in market value or improvements to your property.

What is appreciation or depreciation of property?

The increase or decrease in the value of a property due to factors including inflation, demand and political stability.

What is appraised value?

An estimation of a property’s value before beginning the mortgage approval process. An appraiser (or valuer) is an expert who estimates the value of a property. The lender generally selects the appraiser or valuer before sanctioning the loan.

What is equity? How can I use equity in my home loan?

Equity refers to the difference between what your property is worth and how much you owe on it. Essentially, it is the amount you have repaid on your home loan to date, although if your property has gone up in value it can sometimes be a lot more.

You can use the equity in your home loan to finance renovations on your existing property or as a deposit on an investment property. It can also be accessed for other investment opportunities or smaller purchases, such as a car or holiday, using a redraw facility.

Once you are over 65 you can even use the equity in your home loan as a source of income by taking out a reverse mortgage. This will let you access the equity in your loan in the form of regular payments which will be paid back to the bank following your death by selling your property. But like all financial products, it’s best to seek professional advice before you sign on the dotted line.

What is a loan-to-value ratio (LVR)?

A loan-to-value ratio (otherwise known as a Loan to Valuation Ratio or LVR), is a calculation lenders make to work out the value of your loan versus the value of your property, expressed as a percentage.   Lenders use this calculation to help assess your suitability for a home loan, and whether you need to pay lender’s mortgage insurance (LMI). As a general rule, most banks will require you to pay LMI if your loan-to-value ratio is 80 per cent or more.   LVR is worked out by dividing the loan amount by the value of the property. If you are looking for a quick ball-park estimate of LVR, the size of your deposit is a good indicator as it is directly proportionate to your LVR. For instance, a loan with an LVR of 80 per cent requires a deposit of 20 per cent, while a 90 per cent LVR requires 10 per cent down payment. 

LOAN AMOUNT / PROPERTY VALUE = LVR%

While this all sounds simple enough, it is worth doing a more accurate calculation of LVR before you commit to buying a place as there are some traps to be aware of. Firstly, the ‘loan amount’ is the price you paid for the property plus additional costs such as stamp duty and legal fees, minus your deposit amount. Secondly, the ‘property value’ is determined by your lender’s valuation of the property, not the price you paid for it, and sometimes these can differ so where possible, try and get your bank to evaluate the property before you put in an offer.

What does pre-approval' mean?

Pre-approval for a home loan is an agreement between you and your lender that, subject to certain conditions, you will be able to borrow a set amount when you find the property you want to buy. This approach is useful if you are in the early stages of surveying the property market and need to know how much money you can spend to help guide your search.

It is also useful when you are heading into an auction and want to be able to bid with confidence. Once you have found the property you want to buy you will need to receive formal approval from your bank.

How much money can I borrow for a home loan?

Tip: You can use RateCity how much can I borrow calculator to get a quick answer.

How much money you can borrow for a home loan will depend on a number of factors including your employment status, your income (and your partner’s income if you are taking out a joint loan), the size of your deposit, your living expenses and any other debt you might hold, including credit cards. 

A good place to start is to work out how much you can afford to make in monthly repayments, factoring in a buffer of at least 2 – 3 per cent to allow for interest rate rises along the way. You’ll also need to factor in additional costs that come with purchasing a property such as stamp duty, legal fees, building inspections, strata or council fees.

If you are planning on renting the property, you can factor in the expected rental income to help offset the mortgage, but again it’s prudent to add a significant buffer to allow for rental management fees, maintenance costs and short periods of no rental income when tenants move out. It’s also wise to factor in changes in personal circumstances – the typical home loan lasts for around 30 years and a lot can happen between now and then.

Does Australia have no cost refinancing?

No Cost Refinancing is an option available in the US where the lender or broker covers your switching costs, such as appraisal fees and settlement costs. Unfortunately, no cost refinancing isn’t available in Australia.

Can I change jobs while I am applying for a home loan?

Whether you’re a new borrower or you’re refinancing your home loan, many lenders require you to be in a permanent job with the same employer for at least 6 months before applying for a home loan. Different lenders have different requirements. 

If your work situation changes for any reason while you’re applying for a mortgage, this could reduce your chances of successfully completing the process. Contacting the lender as soon as you know your employment situation is changing may allow you to work something out.