Before you start going out there and making offers on your dream home you first need to ask the question “can I afford an investment property?”
In order to answer this question you need to first understand your borrowing capacity and how this property will affect your cash flow. I suggest using the 7 steps below to work out whether or not you can afford an investment property, or to discover what price investment property you can afford.
There’s no point going out dreaming about buying a certain type of investment if you’re actually not able to afford it. A lot of potential investors waste a lot of time looking at properties that they really can’t afford. They could have been spending that time looking at potential investments that would have moved them towards their financial goals.
Now we’ll go through some questions that you can ask yourself and some steps that you can take in order to work out whether or not you can afford an investment property and how much you can afford to spend.
Step #1. Find Out Borrowing Capacity
So the first step is actually to find out what you’re borrowing capacity is. There’s multiple ways you can do this you can use the online calculators that are available however they aren’t exactly accurate. I did and interview about these online calculators and whether they are actually accurate or not and the fact is that not exactly accurate and they also don’t provide you with any pre–approval
So if you’re just using online calculators you’ll never actually sure that you can borrow that much. Try them to get a rough guide but don’t take them too seriously.
You can walk into your bank and you can talk to them but that’s probably not the best solution either because there are over 30 lenders out there and your bank might not actually be the best lender for you.
The best strategy that I recommend is to talk to a mortgage broker. They can simply give you a call, work with you and find out how much you can borrow. But they can also take you to the next step of getting pre-approval on that loan. This means that when you going out and you’re looking at properties you know that you have approval based on a valuation of that property and so you can actually afford the properties that you’re looking at.
Step #2. Choose Your Price Range
Once you know how much you can borrow then to choose your price range. Just because you have a borrowing capacity of $600,000 or $800,000 that doesn’t necessarily mean that you’re buying range is going to be $600,000-$800,000 dollars.
Buying ranges will vary depending first on what deposit you have. You’re probably going to need a minimum deposit of 5% plus stamp duty unless you’re getting concessions on that. So depending on how much money you can save that might limit how much you can borrow because obviously to borrow a larger amount you need to save greater amount
The other thing that’s going to determine what price range you want to look at is how much can you actually afford to spend on interest repayments.
If this is a property you’re going to be living in yourself you need to work out the mortgage repayments as well as all that other costs with owning your own home (like council rates, insurances, water, electricity all of that sort of stuff). You need to ensure that you can afford this property. Because even though the bank’s may lend you $600,000 if you purchased a property at the higher end of the spectrum and then find out you can’t afford it well that’s going to be very difficult for you.
Choose your price range based on your deposit based on how much you can afford, not what the banks are willing to lend you.
Step #3. Do A Cash Flow Analysis
You will likely want to do a cash flow analysis to see whether or not you can afford the property and to see how much it will cost you or make you each week/month/year.
When doing a cash flow analysis on an investment property you want to analyse the rent coming in as well as the expenses going out and work out whether your property is positive cash flow (if so by how much) or whether your property is going to be negatively geared (if so by how much) and can you afford that?
If you are doing the cash flow analysis on a property you will personally live in then you still need to analyse the expenses however there will be no income to take into account.
The easiest way to calculate whether a property is going to be positive cash flow or not is to use the Advanced Property Calculator which is a tool that is available to all On Property Plus members. It’s an extremely powerful tool which shows you an estimate of the weekly cash flow a property is likely to produce. This is important because you want to know what you going to be paying or what you’re going to be making from a property before you go ahead and invest.
This can be done manually by hand as shown here, but it is a very time consuming process.
Step #4. Assess If You Can/Want To Afford It
You must then assess (based on your cash flow analysis) whether you can afford that property or whether you want to afford it. Maybe you can afford that $100/week negatively geared property but that doesn’t necessarily mean you want to go ahead and invest in that.
It will largely depend on your financial goals and your strategy. You may want to hold out for different property that doesn’t cost you so much or that actually makes you money!
Step #5. If not – Find A Cheaper Property Or One With A Higher Rental Yield
If you find out that you can’t afford a property, let say it’s too negatively geared or let’s say you’re purchasing your own home and you realise that you cannot afford it, the next step is to look at either a cheaper property or a property with a better rental yield.
With cheaper properties obviously you’re going to have less of a mortgage which means less expense on that property. This is going to vary from property to property if you buy a property that needs major renovations of major maintenance that it can cost more than a more expensive property but you made your expense which is going to be a mortgage is going to be less on a cheaper property.
You may not be able to afford a property in a certain price range but if you go lower down maybe you can afford those repayments.
Also if you increase your rental yield then you have the opportunity of the rent paying more of your expenses and therefore the cost of owning that property is less. It could even flip and become a positive cash flow property where it’s actually paying you money every month even after covering the expenses.
This passive income can then be used to pay down the mortgage can be used to reinvest or it can be used to put towards your lifestyle or to save as deposit for the next property.
Step #6. Repeat Steps 3 + 4
After finding a cheaper property (or a property with a higher rental yield) repeat steps 3 and 4. Do a cash flow analysis again and then assess whether you can afford it and if it’s still too expensive find a cheaper property or find a property with a higher rental yield.
If you’re looking for properties with high rental yields and you’re struggling to find them you might want to check out On Property Plus which is my premium membership website. Every single week I list new high rental yield property’s that are highly likely to generate a positive cash flow. I also go through and list a bunch of different data points about that property things like: previous sales price, cash flow, historic capital growth trends in the area, population growth or decline the area, vacancy rates and all the sort of data that will help you to make a wise investment decision.
Step #7. Create A Savings Plan For Your Deposit
Once you worked out what you can afford create a savings plan in order to save your deposit because you will need a deposit in order to purchase an investment property.
If you already own your own home and you’ve got equity you may want to look at equity loans in order to purchase that next property without needing to require saving a deposit. However if you are going to get those equity loans make sure that you know that you can afford the extra repayments because obviously an equity loans is still a loan and brings with it extra levels of debt.
So I hope that this helps you answer your question: Can I afford an investment property?
Really you need to go and speak to a mortgage broker find out exactly how much you can borrow and then work out how much of a deposit you can save and what’s type of property you can afford using the steps I mention in doing that cash flow analysis.
Until next time stay positive.