Knowing how much you should borrow for an investment loan is a little like eating at an all-you-can-eat buffet; just because the money is available to you, doesn’t mean you should borrow it all.
Investing in property is a wonderful way to build an investment portfolio, enjoy long-term returns and take advantage of tax benefits.
But before you enter the market, you’ll want to crunch the numbers to figure out how much you can borrow – aka, your borrowing power.
What is ‘borrowing power’?
Your borrowing power is the amount a lender will loan you.
To establish a figure, lenders will look at your annual income, monthly expenses, current interest rates, the loan term and the type of loan you’re applying for.
They’ll also look at existing debts and financial commitments, such as credit cards and lease agreements (e.g. car and mobile).
When it comes to investment loans, banks and lenders will often approve you for a higher loan than if you were applying for an owner-occupier loan.
This is because they take into account a portion of the rental income the investment property generates.
You can get an estimate right now by using the ME borrowing power calculator.
Should I borrow the full amount?
Now, just because a lender says it will loan a certain amount doesn’t mean you should always take it.
It’s important you consider how a loan could affect your lifestyle (this could mean fewer holidays and dinners out) and any future plans you have, like starting a family or pursuing a new career.
For example, you may be able to borrow $450,000 from the bank and comfortably make your monthly repayments now.
But if you plan on starting a family next year, you’ll incur new costs that weren’t factored into your initial budget.
There are other ongoing factors you’ll need to consider too. These include:
1. Property manager fees
If you don’t want to manage the property yourself, you’ll need to hire a property manager. They normally charge between 6 and 10 per cent of the total rent.
2. Property vacancy
Not everything always goes to plan. So, if there are periods where your property doesn’t have tenants, could you make the mortgage repayments alone? Paying your own rent plus your loan repayment could get you into a financial pickle if you’ve over-borrowed.
3. The cost of repairs and maintenance
As a landlord, it’s your job to pick up the tab for all maintenance works and repairs. In fact, in Victoria under the Residential Tenancies Act 1997 landlords have a duty to ensure the property is in good working order. In other states similar obligations apply under the laws dealing with residential tenancies in those states.
4. Body corporate or strata fees
If your investment is part of an apartment block or townhouse complex, it will be part of a body corporate. Fees can vary (by thousands), so before you buy, check to see if these quarterly levies are within your budget.
5. Council rates
From bin days to parks to new roads, property owners are expected to pay rates to look after and keep their local council humming.
6. Interest rate rises
Depending on the loan you take out, if interest rates were to rise, could you afford the repayment increase? Sometimes, borrowing a little less can take the stress out of unexpected rate rises.
7. Insurance
Just like a car or going on holiday, you’ll want to insure your investment property.
Landlord insurance covers you for tenant-related risks, such as loss of rental income and tenant damage.
It also provides cover for flood, storm or rainwater damage and fire damage – without insurance, you could end up in serious debt.
The exact amount you choose to borrow from your borrowing capacity is up to you – there are no official rules.
By crunching the numbers and factoring in your future plans, you can find the right loan that doesn’t overstretch your financial capacity.
This article originally appeared here.