If you go to property investment seminars, read those ‘1 to 100’ books and follow enough so called ‘experts’ you might start to believe the property game is all about buying one property after another until you’re wealthy enough to retire.
And look, I’m not saying it can’t be done. But lots of investors we initially chat with need to have their expectations realigned.
Its more about understanding the financing side to the investment.
In this blog, we’ll explore exactly what it takes to add more properties from a financing perspective to your fund your portfolio.
On the go? Here’s 30 seconds of take outs:
- To continue to grow your property portfolio you need strong income/savings and the ability to overcome Loan Value Ratio (LVR) and Debt Service Ratio (DSR).
- Banks tend to consider 40 – 45% the limit for DSR and the average investor may not be able to achieve this benchmark in subsequent property deals.
- Focusing on savings and strong income will provide the best environment for banks to consider lending you more.
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The one property after the other investment strategy requires cash and income that the average investor just doesn’t have access to. And it’s a bit of a myth unless you can overcome:
- Loan to Value Ratio (LVR)
- Debt to Service Ratio (DSR)
A loan to value ratio is more of a security position. Think about it, anytime you are wanting finance anything very rarely someone will give you a loan without some sort of collateral housing finance is no different – You’ll need to have a deposit or equity in most cases .
Deposit & Loan Examples
Purchase price $400,000
- 12% Deposit $48,000 = An 88% (LVR) Loan: $352,000
- 20% Deposit $80,000 = An 80% (LVR) Loan: $320,000
- Present Value: $400,000
- Present Debt: $200,000
- Equity: $200,000 = Present Value – Present Debt
Equity loan Example
80% of Present Value = $320,000
New Equity Loan: $120,000 = 80% of Present Value ($320,000) – Present Debt ($200,000)
Which can be used as the deposit for a new purchase depending on your (DSR).
Before we jump into the example, please note that while I did receive help writing this article from Chris Raymond at Unconditional Finance there are many factors a bank will use when determining whether to provide a loan, for example rent where you live and other living expenses / cost of living, expenses running your investment property. So this example should be taken as an example only.
The average investor we work with:
- earns about $75,000 per year
- has around $50,000 – $70,000 cash in the bank
- has low level credit card / personal loan debt
- has a borrowing capacity of around $400,000 – $450,000 for an investment property
Let’s say you’re an average investor, you have your first property up and running and you’re receiving rental income.
- Purchase price $400,000
- 12% initial deposit $48,000
- Loan amount: $352,000 + [Lenders Mortgage Insurance] $5,033 = $357,033
- Loan repayments (stress tested*): $357,033 @ 6.3% principal and interest repayments = $26,520 p/a
- Rental Income: $350 p/w x 52 – $18,200 @ 80%** = $14,560 p/a
*Stress tested repayments are when the lender adds a couple of percentage points on the variable interest rate to allow for any interest rate increases to make sure you able to meet your repayments. The example above the real or actual interest rate could be 4%.
**Banks will typically use only 80% of the rental income for servicing the loan.
Now you’re two years into your first purchase and you’re looking at a second property.
- Purchase price $380,000
- 12% initial deposit $45,600
- Loan Amount: $334,400 + [Lenders Mortgage Insurance] $4,781 = $339,181
- Loan Repayments (stress tested): $339,181 @ 6.3% principal and interest repayments = $25,200 p/a
- Proposed Rental Income: $330 p/w x 52 – $17,160 @ 80% = $13,728 p/a
A simple way to look at borrowing capacity and DSR for this second property would be to calculate total debt divided by total income. As a general rule, a 40 – 45% DSR will be the limit at which a bank will lend you money.
- Earned income / wages: $85,000
- Rental Income / proposed rental income: $14,560 + $13,728 = $28,288
- Total: $113,288
- Loan interest for property 1: $26,520
- Loan interest for property 2: $25,200
- Total: $51,720
Total loan interest / total income* 100 = debt to service ratio:
- $51,720 / $113,288 x 100 = 45.6% of income servicing debt
In reality, banks won’t continue to lend you money deal after deal unless you have the cash and the ability to service the loans. And what that comes down to is strong income!
Put yourself in the eyes of the bank for a moment. The bank’s main concerns are:
- Receiving regular loan repayments
- If things don’t go to plan, they can get their money back
Banks want to see secure employment. Being a Defence Member is a huge tick in the banks books. They have the assurance that you have a stable, predictable and secure job. Unless you change career paths, your income is all but guaranteed.
And banks also love seeing a cash deposit. Because if things go south, they have better chance of getting their money back.
For example, if you’re unable to service your loan and miss your mortgage repayments for 3 months the bank can repossess and sell your property through the mortgage repossession sale.
Saying this, banks are wanting to help you, this is the last thing they want to happen. They are willing to work with you and work through some sort of plan. All is not lost unless you let it happen.
I did receive help writing this article from Chris Raymond at Unconditional Finance
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