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Affordability Is The Key Word

Peter Norris explains there’s more to it than simply can you afford the loan repayments, or does the bank calculator think you can.

By: Peter Norris

2 July 2023

Affordability is a topic we as financial advisers discuss regularly. In fact, every client interaction, in some capacity, comes back to affordability. How much can I borrow? What interest rate will I pay, or how much will I need to contribute to this investment property lending?

When it comes to buying investment property, affordability is about your ability to afford the property. This seems obvious, I know, however it’s not entirely that simple. If it were wouldn’t it be a lot easier to know whether you can borrow money or not?

There’s more to it than simply, can you afford the loan repayments? Or does the bank calculator think you can?

When it comes to borrowing money for the purpose of buying an investment property, the affordability of that lending is as much about what the bank thinks as it is about what you think you can actually afford based on your lifestyle.

OK, maybe that’s a stretch. You fundamentally can’t borrow money if the bank says “no”. What I mean is just because the bank says you can afford a new loan of $1,000,000 (based on their calculations), doesn’t mean that amount of lending is what you should take.

The Bank’s View

You need to understand your own personal situation and what affordability means to you.

Let’s focus on what a bank wants to see. When a bank’s determining what level of lending is affordable for you, they’re primarily looking at two things: your serviceability and your deposit. You need both of these to be able to meet the bank’s affordability criteria.

This is essentially your income and how much taxable income you have available to service the lending you are asking for. Every bank has different policies for how much income they can use, depending on the source. For example, PAYE is always going to be the easiest, because the banks use 100 per cent of it. However, bonus income, commission, or self-employed income has variables across every bank.

Whenever I’m talking to clients about what they can borrow I try to keep it incredibly simple and leave a bit or margin for error. A simple debt-to-income calculation will give a good idea of what’s possible. This is where you take all of your annual income and multiply that by a certain number to get a maximum loan amount.

The question though is what’s the number?

If you had asked me 12 to 18 months ago I would have said you can borrow between seven and eight times your income. However, given the increase in interest rates and bank test rates, that number is now between five and six times. I tend to err on the side of caution and suggest to clients they can borrow around five times their income, and then look at possible changes they can make to increase that number, for example reducing consumer debt and credit card limits.

The Deposit

Like I said, this is a very simple method and is by no means a guarantee. However, it’s a good way to give you a simple baseline for what’s possible ahead of going through a full application.

The amount of deposit differs depending on what type of investment property you are buying. Up until recently the deposit requirement for an existing (second-hand) investment property has been 40 per cent. However, that’s recently changed to 35 per cent, which means you now require a smaller deposit.

New builds remain exempt from the Loan-to-Value (LVR) restrictions. This means the deposit required to buy a new build investment property is only 20 per cent.

For example, say you have a deposit of $150,000. This would allow you to buy an existing investment property for up to $428,000, but it would allow you buy a new build investment property for up to $750,000.

Your deposit can come from either cash (savings or a gift etc) or from equity in your existing property, or a mixture of both.

When it comes to equity, remember that it’s not 100 per cent of the equity in your existing property that you can use towards your next deposit. Your usable equity is limited by the same LVR restrictions as when you’re buying.

Good Example

Let’s say you own two properties – your home plus one investment:

Home – Value $1,000,000 Lending $700,000

Investment property – Value $800,000 Lending $400,000

In this scenario, you could borrow 80 per cent against your home and 65 per cent against your existing investment property. This means you would have usable equity of $220,000, which then becomes your deposit for your new property.

Like I said earlier, when looking to borrow you need to have both the serviceability and the deposit. If you have one but not the other, then you’ll need to work on ways to increase that missing piece in order to buy. And if you aren’t sure what to do, then I’d suggest working with a financial adviser on strategies to achieve that next step.

Peter is director of Catalyst Financial. Catalyst specialises in mortgage, insurance and investment advice specifically for property investors. To see how Catalyst can help you achieve your financial goals, check out www.catalystfinancial.co.nz or contact [email protected]


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