Owning rental properties is a common kiwi dream. Many of us envision going into retirement with a couple or more of freehold properties under our belts, bringing in a nice amount of money each week to supplement our superannuation payments. Or perhaps just selling the properties off and sailing into the sunset, weighed down by all the cash.
If you’re looking at how feasible it would be to buy your first or an additional investment property, it pays to know how the bank will weigh up your application.
The banks take a conservative approach when stress-testing an applicant’s ability to support a mortgage. This is in line with the lending rules created and enforced by the Responsible Lending Code. While the conservative approach can lead to frustrating outcomes for some, they do it to ensure (as much as possible) mortgage holders don’t overextend themselves and are able to weather high-interest rates and unexpected costs.
Banks stress test a number of things to decide whether a mortgage should be approved, including:
Ultimately, as you build your property portfolio, you will likely find no problem in growing equity but your income will become more and more of a limitation. While not easy, increasing your income is the most likely solution, as well as keeping your expenses and liabilities to a minimum.
Let’s look at a couple with a combined income of $150,000. They own their own home and one investment property. They get $25,000 in rent each year from their investment property. They owe $1 million on a 30-year-mortgage, are paying about $25,000 in interest and about the same (in the first year) in principal payments. This comes to about $47,000 per year in mortgage payments.
The couple has two credit cards and an overdraft option for their bank account. They use the credit cards for all purchases as they get reward points but they pay the cards off each month. They don’t feel they need the overdraft but took it when it was offered by the bank. Between the cards and the overdraft, they have the ability to go into $50,000 of debt.
They’re keen to add another property to their portfolio. They’ve done their own calculations and have concluded that with the right property they would be able to cover an additional mortgage of $500,000 and any unexpected costs if necessary, especially at the low-interest rates the bank is currently offering.
But the bank calculates both their current mortgage and any possible additional mortgage by:
Given the above, the bank is unlikely to approve an additional mortgage. If the couple were to reduce (or remove) their credit cards’ limits, review the rent for their current home, look at getting a pay rise and find a bank that calculates investment mortgages over 30 years, this could change a no from the bank to a yes.
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