How much can I borrow for an investment property?

More and more Australians are looking to invest in property as a way to build wealth and provide extra funding for their retirement. Currently, more than 2.2 million Australians own an investment property.[1]

If this is an idea you’ve been entertaining, the first step is understanding your borrowing capacity. This can be influenced by a number of factors, including your deposit, income, expenses, and credit score.

In this guide, we’ll walk you through your borrowing capacity (how to estimate it and how to increase it), as well as how lenders assess your borrowing power.

What is an investment property?

An investment property is a property purchased with the intention of making a return on investment. This might be through generating rental income, future resale, or a combination of both. Either way, an experienced property manager is key for helping you minimise risk and maximise your return on investment.

Investment properties allow investors to develop equity in an asset that can be leveraged over time. It gives investors the ability to keep up with repayments and deliver rental income, and – in many cases – enables them to accumulate wealth as the property value increases.

Investment loan vs owner-occupied loan

So – how do you start investing in property? Most people will need a loan, so understanding how much you can borrow for an investment property is a good place to start. Your two main options are an owner-occupied loan or an investment loan.

An owner-occupied loan is a mortgage taken out by people who intend to live in the property as their primary residence. These types of loans usually come with lower interest rates and more relaxed lending criteria.

An investment loan is used to purchase a property that will be rented out or held for capital growth. Investment loans are typically viewed as being riskier than owner-occupied loans and typically come with higher interest rates and stricter lending criteria.

Both loan types are assessed based on borrowing power, which depends on factors such as your taxable income, living expenses, credit history, and existing debts.

Some people choose to refinance their current owner-occupied home to help them access equity to invest in a new property. However, as borrowing for investment comes with additional considerations such as rental income, loan structure, and income tax implications, it is essential that buyers understand these differences when deciding upon the best financing option. Speak with a professional financial advisor for guidance.

What is borrowing power?

‘Borrowing power’ is a term that you’ll often hear associated with mortgages. It relates to the amount of money a lender is willing to advance you. It is a key factor in purchasing an investment property because it determines how much debt you can afford to take on.

Borrowing power is not a fixed number. It will be different for everyone, as well as by external factors such as your potential rental yield, which lenders will determine when assessing your investment loan application.

For this reason, it is important to get a loan pre-approval, as this will help you budget effectively and with confidence. It will also make your offer more attractive to sellers.

How do lenders assess your borrowing power?

Before agreeing to loan you money to purchase an investment property, lenders will thoroughly evaluate your borrowing power.

"When banks assess borrowing capacity, they factor in income, expenses and liabilities, which are all treated differently,” said Fane Levy, Senior Credit Adviser for Shore Financial. “The banks will utilise 100% of salary, but generally 80% of commission/bonus and, if it is an investment property, between 80 to 90% of the rental income.”

Here are seven things lenders are likely to consider.

1. The amount of your deposit (and whether you need LMI)

Your deposit is one of the most significant factors lenders consider when assessing your borrowing power. The larger it is, the lower the risk you’ll pose to them.

If your deposit is less than 20%, you may have to pay Lenders Mortgage Insurance (LMI), which adds additional costs that will reduce your lending capacity.

2. Your existing equity

You may be able to use the equity in your home as a deposit for an investment loan. The more you have, the more you’ll be able to borrow.

3. Your income and expenses

Lenders will compare your salary, rental income, and other earnings against your living costs, debt repayment amounts (including any existing mortgages), and financial situation.

“In terms of liabilities, [lenders] will expense out existing debts such as home loans, car loans, Higher Education Contribution Scheme (HECS), and will also apply a 3% buffer on credit card limits - so existing liabilities can certainly reduce borrowing capacity,” Fane said.

Having a high disposable income will increase your borrowing capacity.

4. Credit history

A strong credit score and repayment history will also significantly improve your chances of securing a bigger loan.

Conversely, if lenders see you have a track record of late or missed payments, it will limit your borrowing power.

It’s a good idea to get your finances in sparkling shape for at least six months prior to applying for a loan. Make payments on time and in full, spend wisely, and give lenders every reason to say yes to your application.

5. The loan type you’re applying for

Lenders will assess the type of loan you’re applying for. Interest-only loans give you a higher borrowing threshold, while principal-plus-interest loans reduce your debt faster, albeit with higher repayments.

6. The property type and location

Lenders favour properties in high-demand suburbs that offer stable rental returns and steady growth. If you intend to purchase a property that is remote or in a high-risk area (due to floods, fires, rising sea levels, or other environmental issues), your buying power might be reduced due to the risk.

7. Your investment strategy

Your long-term investment goals may be evaluated. If so, presenting lenders with a strong, professionally drawn-up strategy that contains solid rental income projections will likely help your application.

How to estimate your borrowing power

Knowing your borrowing power and how much you can borrow for an investment property (before formally applying for an investment loan) allows you to be proactive.

Using a home loan calculator is an easy way to do this. (Most major banks offer free online home loan calculators.) This tool will provide you with a quick estimate based on an overview of your income, expenses, existing debts, and equity.

If you want a more precise figure, speak with a mortgage broker or lender. They can perform a more detailed assessment and consider factors like your credit history, deposit size, and rental income projections when determining your borrowing power.

It also worth noting that Mortgage Brokers like Shore Financial have access to lenders that can waive LMI up to 90% for certain professionals (DR, Lawyers, solicitors, and Frontline Emergency Workers - Nurses, Police Officers, Firefighters and Paramedics) and even up to 95% without LMI for Dr’s. “This is a huge advantage to help these potential clients get into the property market with a smaller deposit requirement.” Says Fane Levy, Senior Credit Adviser for Shore Financial.

5 tips for increasing your borrowing capacity

If you want to boost your borrowing power, there are steps you can take. Here are five tips for increasing your borrowing capacity.

1. Reduce existing debt

If you want to increase your borrowing capacity, getting rid of your debt is one of the best ways to do so. Lenders factor in your total liabilities when assessing your borrowing capacity, so pay down your loans and credit cards (and reduce the limits).

2. Increase your income

The more money you earn, the greater your borrowing power might be. Consider getting a higher-paying job or developing a secondary income stream.

3. Lower your expenses

Another excellent way to increase your borrowing capacity is to reduce the amount of money you spend. Look for ways to lower your recurring financial commitments and cut back on discretionary purchases.

4. Improve your credit score

If your credit score is low, you can improve it by paying your bills on time in full, reducing any outstanding debts, and not purchasing things on credit.

5. Pull together a larger deposit

The larger the deposit you can save, the more it reduces the loan-to-value ratio (LVR). Doing this lowers the level of risk financial institutions perceive there to be in lending you money and eliminates the need for Lenders Mortgage Insurance (LMI).

6 additional costs to consider when buying an investment property

Along with the purchase price of your investment property, you’ll need to plan for additional costs in order to determine the affordability and potential profitability of your investment property. Here are six of the most common costs to factor in.

1. Stamp duty

Stamp duty is a tax based on the value of the property you intend to buy and varies per state. However, it can impact upfront expenses quite significantly.

2. Legal fees

This covers conveyancing and the drawing up of contracts to ensure the property settlement is legally sound.

3. Building and pest inspections

It is important to have these inspections done to identify structural issues or infestations. Failure to do so can result in costly repairs down the line.

4. Insurances

There are several types of protections you might consider taking out to safeguard your property, including landlord insurance and building insurance.

5. Property Management Fees

If you engage the services of an experienced property manager (and here’s why you should), you can expect ongoing fees and charges for managing tenants and coordinating any maintenance that needs doing, which you will have to pay separately.

6. Council Rates

Local government charges for services like waste collection and infrastructure will also need to be covered.

Summing up

Investment properties are an excellent way to grow your wealth. As with any endeavour, being prepared and proactive goes a long way towards ensuring success and mitigating risk.

Before applying for an investment property loan, it is important to know your borrowing power. It’s also important to work with experts like DiJones. We can help guide you towards choosing the right investment property and we have experienced property managers who can help take care of your investment. Contact us today to learn more.

FAQs

Can I borrow more for an investment property?

Yes. While your borrowing power depends on your income, expenses, loan balance, and credit history, lenders may offer higher loan amounts for investment home loans by factoring in potential rental income.

Using home equity or equity to buy another property can also help increase your overall borrowing capacity.

How many properties can you own in Australia?

There’s no limit, but your ability to afford an investment property does depend on your loan repayment capacity. Lenders will assess your loan term, loan option, and property value before approving you for multiple loans.

How do interest rates affect my borrowing power?

Higher home loan rates or interest rate changes can influence your monthly repayment, which can affect your borrowing capacity. However, if you compare variable home loans, fixed home loans, and comparison rates, it can help you find a rate option that works for you.

Should I get financial advice before investing?

Financial advisers or lending specialists can provide expert advice on things like property finance, market value, managed funds, and negative gearing strategies. It’s always worth seeking out a professional opinion.