Can I afford the cost of investment property?
Many people assume that buying an investment property is beyond their reach financially, but interestingly, most people can afford an investment property – even individuals and families with smaller incomes. In fact, one of our clients now owns five properties and got started with an income of less than $40,000 per year.
Beginning with budgeting
A great place to start is by working out your personal budget – how much you earn, how much you spend, and how much is left over each week.
But don’t worry if you don’t have a lot left over; many property owners simply get the taxman (aka the ATO) to pay for (or at least chip in) part of the cost of their investment property.
How, you ask? It’s simple. The cost of running your investment property may allow you to claim certain tax deductions.
Answering two key questions
In other words, don’t let the numbers get you down before you even get started. Ultimately, the answer to the question, “Can I afford an investment property?” comes down to answering two simple but important questions:
• Can I complete the purchase, and can I afford the costs of ongoing ownership?
Here, we help you understand – and crunch – these critical numbers.
Completing the purchase
Among the costs of initially purchasing your investment property is, of course, your deposit, which typically ranges from 5 to 20% of the property’s purchase price, depending on how much your lender is willing to give you.
Other important costs to consider include an allowance – usually, about 5% of the purchase price – to cover your solicitor’s conveyancing fees, any bank fees, stamp duty, and any other taxes. If you also need lenders’ mortgage insurance (LMI), then this can add up to another 3% on top of your deposit and other costs. This typically applies only when you borrow more than 80% of the value of the property. It’s also important to note that stamp duty and some property taxes vary by state and territory.
The great news is that you don’t need to have the cash for any of these costs if you have enough idle equity in your home. More on this below.
Certainly, there are online calculators that can help give you a rough estimate of all these costs, but you’ll also want to speak with a qualified mortgage broker who can take you through the numbers in much greater detail.
Once you’ve got a handle on these initial purchasing costs, you need to look closely at your finances and figure out whether you have enough cash, equity in your current home, or combination of both, along with sufficient borrowing capacity, for the deposit and other fees.
Your home equity is the market value of your property minus what’s left on your mortgage. However, the important number to focus on is your idle equity, which is the difference between what the bank will lend you and the balance on your mortgage. For example, if the market value of your current home is $800,000, and the balance on your mortgage is $400,000, your home equity is $400,000. If the bank will lend you 80% of $800,000, or $640,000, less the balance on your mortgage of $400,000, then you have $240,000 in idle equity. This is the equity that sits idle, and that’s what you can use to purchase an investment property.
As for your borrowing capacity (the amount you can borrow from a lender), again, there are online tools that can help you get a rough idea of what you’re likely to get. However, it’s a better idea to talk to the professionals who can really explain your borrowing power and the associated financing options.
Managing ongoing ownership
Now that you’ve got the initial purchase covered, it’s time to make sure you can afford the costs of ongoing ownership. These costs include your mortgage, council rates, insurance, utility (water and electricity) costs, maintenance and repairs, and body corporate fees (if they apply).
You need to calculate these total monthly expenses and subtract the monthly rent – your rental yield – you will receive. If your rental yield is high enough, your interest rates are low enough, or the amount of tax you pay is significant enough, many properties can generate positive cash flow for you, particularly after tax.
At the end of the day, you have to look at this cash flow and determine whether you can afford it and still live the way you want. When you crunch the numbers and take into account any unexpected problems that may come up with a property, such as periods without tenants, are you comfortable taking on this financial commitment?
If you’re thinking about buying an investment property and you want someone to take you through the numbers and help you explore your options, Allied Investment Group can help. Call us today on 1300 886 149 or request a Free Consult.