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Rental Investors: What Size Mortgage Bond Can You Get?
Thinking of investing in rental property in Hobart? Finding finance for your investment property involves a lot of number crunching, budgeting and projecting by both you and potential lenders. Baxton Property Management in Hobart explains how banks in Tasmania work when calculating what they are prepared to lend you.
Calculating your risks
Both you and the bank have to calculate the risks involved in your purchase of a rental property. The banking system’s process is totally designed to lessen their risk in lending you the money. However, it’s important you evaluate your own risks, before committing to a long-term contract with the bank and putting your new property on the line to underwrite it.
How much can you borrow?
Banks use two formulas, one based on the property’s value, and the other on your ability to pay off the mortgage. To cover itself, the bank needs to know there’s enough value in the mortgaged property to cover them, and that you have sufficient income left over after expenses and debt payments to pay off your mortgage so it doesn’t ever have to gamble on that property’s value to recover the capital.
Banks usually lend larger amounts to rental property investors compared to private home-owners, because the property will be generating an income and has associated tax benefits that will assist you in repaying the loan.
The value of your property
The Loan to Value Ratio (LVR) on the investment property plays a vital role in determining what size loan you qualify for. The LVR varies according to the state of the property market and is influenced by your loan and banking history, but will currently be around 85-90% of an investment property’s value. That would then be the amount you can borrow, provided you are considered able to pay it back.
The LVR is calculated by dividing the desired bond amount by the value. As an example, a $750,000 bond on a $1million property would have a LVR of 75%, which is comfortably within the limits.
Calculating your ability to pay
Some banks still use the DSR or Debt Servicing Ratio to calculate your ability to pay. It works by dividing the repayments you would have to pay annually on the loan by your gross taxable income. This determines what percentage of your total income could go on repaying the loan. A positive ratio would be 30 to 35% of your annual income.
However, many lenders have moved away from the DSR towards using a Net Surplus Ratio Index instead. This system takes your monthly income (after tax) less your monthly living expenses, and divides it by your total monthly commitments, including both your existing debt and the new debt the mortgage or investment loan would add. If the ratio is less than 1 to 1, you would be unlikely to be granted the loan. Most lenders actually call for a ratio of 1:1.00 but you would be more likely to land a loan if the ratio were 1:1.05, 1:1.10 or higher still as at least then you would have a little in the kitty for bad months.
Income versus expenses
Your personal income: The bank looks at how much money you earn per hour, week, month or year before deductions, and without added extras. Your borrowing power therefore revolves around the base income that you see on your payslip. When it comes to overtime, commission and bonuses, some banks okay its inclusion in full, provided you can show they’ve been regular for a couple of years at least, and are likely to remain so. Otherwise they may include only half the value, or none at all.
Rental income: Banks usually accept about 80% of it into their calculations, cutting the remaining 20% as the likely cost of repairs, rates and management charges.
Your expenses: These include taxes and existing debt commitments like current mortgages, car payments, credit cards and loans. Personal expenses associated with daily life are then added, usually according to the Household Expenditure Method (HEM) based on figures gathered by the Australian Bureau of Statistics. All expenses associated with the rental of the property would also be included. For a new rental, where the income is not yet known, an extimated projected figure could be around 4% of the property’s value.
The Baxton Property Management team has garnered the experience of a century of activity in the investment property field. This has inspired them to spread information of interest and importance to their clients and their tenants. Visit Baxton on their website.
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We hope you enjoyed this article
The information contained in this article is based on the authors opinion only and is of a general nature which is not indicative of future results or events and does not consider your personal situation or particular needs. Professional advice should always be sought relevant to your circumstances.
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