Can I Afford An Investment Property?

You have finally decided that you want to invest in real estate…this is a great decision. The question is, “Can you afford an investment property?”

In this article I will walk you through the analysis you need to do so you can determine if you can afford to buy your first investment property. I will also reveal some little known strategies and tips to help you find more funds and start investing quicker than you ever thought possible.

I am going to ask you 4 simple questions that I need you to answer honestly. This analysis will help you to find out what you really can afford so you can get started.

What Is The Smallest Deposit You Need to Afford Your Investment Property?

The lowest deposit lenders seem to be accepting these days is 5% of the selling price. Some say it’s 5% to 10% for investment properties, but many lenders are happy to accept 5% deposit. If you have another property, like the one you live in, you could use the equity from it to cover some or all of the deposit.

The amount of deposit required will vary per lender, so it’s best to ask a lending officer or mortgage broker to assist you.

Using 5% as a benchmark you need to work backwards to find out what type of property you could afford. Let’s say you can only save $15,000, assuming that $15,000 makes up your 5% deposit then you would be able to afford a $300,000 house ($15,000/5 x 100). If you have $30,000 then you would be able to purchase a $600,000 house and so on.

If you want to buy a $450,000 house but you only have $10,000 then you are likely out of luck. It might be a good idea to lower your standards and look at purchasing a house for $150,000-$200,000 instead. They may not exist in your neighbourhood so you may need to look elsewhere to find a cheaper investment property.

If you feel like a 5% deposit is still too much, don’t fret, the government offer incentives to first time homebuyers in Australia.

The FHOG is a government initiative, which aims to make it easy for first time homebuyers to purchase a property. It’s a one-time, tax-free grant worth $15,000 given to qualified applicants who will purchase a newly built property worth up to $650,000 (this is for NSW and may vary from state to state). This grant is not just for people who want to live in the property for the long term, there are certain terms and conditions but it is possible to use the property as an investment after you comply. For some states this means living in the property for 6 months within the first year.

Aside from the FHOG, Stamp duty discounts may also be given to first time homebuyers. The concession given for stamp duty costs vary per state, so the best you can do is ask a broker if you’re eligible before proceeding with a purchase. You should discuss this concession with a broker to determine if the property you want to purchase meets the criteria and buying limits, otherwise you run the chance of reducing the concessions you can get or be unqualified altogether.

For more information regarding government grants, please contact the appointed government office in your state, or ask a licensed real estate agent. Here are some of the government websites:

• ACT
• NSW
• QLD
• SA
• NT
• TAS

What Is Your Available Cash Flow Now?

The next step to assessing whether or not you can afford an investment property is to look at your available cash flow right now. This is NOT savings, this is your weekly/monthly money that goes in and out of your bank account. Income and expenses.

This step is important because you need to know how much money is available to invest and exactly what type of property you can afford to pay for.

To find out how much you can afford to save right now, simply take your income (after tax) and minus your expenses. Is there anything left over at the end of each pay cycle? If there is then you should think about saving that towards a deposit. If you need a $10,000 deposit and you have $500 left over at the end of each month it will take you 20 months to save your deposit.

It is also important to look at your monthly income to assess what size loan you could afford to pay. Lender’s call this the debt-to-income ratio and this is used to work out whether you are likely to be able to repay your loan or not. The general debt-to-income ratio is somewhere around 28%, meaning that banks will lend you a mortgage where the repayments cost 28% of your monthly income.

So if you earned $5,000/month they think you could afford to pay $1,400/month. On an interest only loan at 6% this means you could effectively borrow $280,000. Obviously they take many other items into account also but this give you a rough indication. Thus if you earn $5,000/month you probably shouldn’t be looking to buy a house worth $600,000 (repayments would be 60% of your monthly income…and that’s before we take tax into account).

Where Can You Cut Expenses To Find More Cash Flow?

I am not a fan of the “canned bean” approach. Which says “cut all your expenses and just eat canned beans for a year to save your deposit. This is demoralising and rarely works. However, I do believe finding ways to cut your expenses to save more money for a deposit is an important step.

What if you calculated your net income and found out that you can’t afford to spare money to invest? Then how are you ever going to save for your investment property? The fact is you can’t and you need to do something about it.

Here are a few tips to increase your cash flow (more detailed tips here):

• Cut back on extras
• Use coupons for groceries and other expenses
• Join a carpool to save on commuting and gas expenses
• Cancel the gym subscription you hardly use
• Avoid using credit cards for all your purchases; using plastic will make it harder for you to track your expenses.
• Consolidate existing loans into one loan with lower interest. For instance, if you have several loans at varying interest rates, like one at 13%, then another at 25% and another one at 6%; you can go to a bank and ask for your loan to be consolidated at a lower interest rate. Banks offer many deals like this, and consolidating your loans will help you a lot because you won’t pay as much interest and you’ll only have to pay 1 debt instead of 3 or more. Just make sure you don’t fill up those credit cards again.
• Minimize dual and unpaid services. If you’re subscribed to dozens of magazines, see if you can cancel some of your subscriptions. The same could be applied to cable packages and internet subscriptions. For dual services, do you have a landline and a mobile, too? Consider getting rid of the landline.

Can You Grow Your Income?

Truthfully I believe this is THE MOST IMPORTANT THING you need to consider when asking yourself “Can I afford an investment property?”. The question should not be “Can I grow my income?” and it should be “How can I grow my income?”

Aside from spending less, you may want to consider growing your income. This may take more work and time, compared to making a budget and spending less money on cable TV, but the long-term benefits will be worth it.

• Do you have skills or crafts that could be used to make money outside of work hours? Consider using those to earn extra income? (eg. I have skills in creating websites, I occassionally use this outside of work hours to make some extra money)
• Could you gain a pay rise at your job, or gain a commission portion that is based on your results?
• Do you need to pick up another job?
• Can you sell some of your stuff (maybe on eBay) to raise extra money?
• Could you start a side business that creates an extra income stream you can use for investing?

Being Able To Afford An Investment Property Is Not Easy…But It Can Be Done

No it isn’t easy to afford an investment property, that is why the majority of Australians never invest. However, it can be done. It takes rigour and hard work but you can do it.

Here is a summary of the steps:

First, get a figure of exactly what you need to have saved and be earning to afford the investment property you want. Lower your standards if you need to.

Second, assess your cash flow and cut your expenses so you can use the extra money to put it towards your property.

Third, find ways (don’t just ask can I) to make more money either through your 9-5 job or on the side. Use the extra income to put towards your investments.