If you are thinking about applying for an investment loan it can pay to be prepared and have a solid understanding of what lenders are looking for. This can potentially help you improve your chances of securing a loan.
Here are some of the things lenders may consider when assessing your loan application.
The rental income
When considering your application for an investment loan lenders do consider any rental income you will receive, however, it might not go as far as you may think.
For permanent rentals lenders generally scale the rent back to 70% to 80% of the actual rent received for a suburban house and 60% for a high rise property. This reduction is to allow for potential rental vacancies.
For non-permanent rentals, such as holiday letting and Airbnb, lenders usually look at the rental history – and they might go as far back as the past two years.
As you can see you probably won’t get the full benefit of the rental income, even though most rental vacancy rates are quite low at the time of writing. So, in most cases you will require surplus income from another source to qualify for an investment loan.
The running costs
It’s worth noting that some lenders may also consider the running costs or expenses of owning the property – such as real estate agent management fees, strata, rates, insurance and maintenance – when assessing your application.
They might estimate the amount by inspecting your rental statement or tax returns if you are refinancing an existing loan. Alternatively, they may assume a nominal figure or use an estimate you provide. There is often an allowance for the interest you may be able to claim as a tax deduction to offset some of this.
Your debt-to-income ratio
More recently we are seeing the impact of a factor called ‘debt-to-income ratio’ (DTI) which is essentially the ratio of any lending you have to your income. It is simply the sum of all your debts divided by the ‘allowable’ income. For example, if you have $500,000 in debt and your income is $80,000 your debt-to income ratio would be 6.25.
Keep in mind that debts also include car and personal loans, HECS-HELP loans, buy now pay later schemes and credit cards.
Allowable income is generally your salary, a percentage of your overtime, bonuses and commissions, rental income, and acceptable government allowances. Each lender will have its own policy on what is ‘allowable’.
Additionally lenders have different DTI appetites based on the percentage you are borrowing, and your monthly surplus. For example, you may have a DTI of 6.5 and a surplus income of $200 a month and be knocked back, but if you had the same DTI and a surplus of $500 a month this might be approved.
You could also have a DTI of 8 and be approved somewhere else if there is a strong mitigating factor such as a secondary applicant, loans nearly paid out (and therefore about to reduce your overall credit limits) or multiple properties (you could, in theory, sell one to reduce your overall debt to income ratio).
→ Related: Debt-to-income ratio: what does it mean?
Tips for applying for an investment loan
There are a few things you may be able to do to get everything in order before submitting your application. Here are a few tips.
Look for ways to improve your potential return
We are seeing a huge swing towards positively geared properties or those with higher income streams; dual income from one property, regional areas with good balanced economies and stable futures, outer lying areas where the land is more economic and rent return is better. Improving your return is the number one way to expand your borrowing capacity and potentially your portfolio.
Reduce your expenses
Make sure you understand all your expenses and try to keep them as low as possible. It can also be helpful to know how lenders treat the property-related expenses for the best chance of approval.
Offload any unnecessary debt
There’s a huge benefit in offloading any unnecessary debt – a $10,000 credit card limit can mean an $80,000 reduction in borrowing capacity before DTI is in play. If you have two or three cards, do you need them?
If you are going to accelerate the repayment of any debt it’s a good idea to start with non-deductible or so-called ‘bad’ debt.
Ensure you have a clean credit history
Make sure you are meeting your existing repayments. It’s worth noting that with the introduction of comprehensive credit reporting (CCR), your credit history may include up to 24 months of repayment history, and many lenders give this a lot of credence.
Have your documents in order
It can be a good idea to get all your documents in place. Having this all ready to go can potentially expedite what is currently a fairly slow process due to lender backlogs.
Understand your goals and find the right property
This may seem odd but it’s important to know your why. What’s the ultimate goal and – to some extent – what is the exit strategy?
This in a way defines your strategy and the property choice. People invest for many reasons. If your goal is to buy something that you would ultimately live in when you retire, then your intentions and strategy will be entirely different to someone looking to gain extra cash flow, or someone looking to build a portfolio for potential capital gain.
Something else that has always stuck with me from early days in my career was an investment adviser who had modified the “just add water” philosophy (water views, water access and water proximity generally being always a popular driver for growth) to “just add storage”. Stick a shed in the backyard, he said, and your tenants will fill it with their ‘crap’ and never want to bother moving.
Cover image source: fizkes (Shutterstock.com)
About Rebecca Jarrett-Dalton
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