Buying Rental Property? Seven steps you need to know

Buying your first rental property

You know that you want to buy an rental property eventually, but unsure of where to start?

This is a thought that many first home buyers and investors have when deciding how to enter the property market. Buying a rental property is a great avenue to rent out a property for an ongoing income stream. Many property investors are searching for that piece of the Australian dream. Robert Kiyosaki explores the difference between homeownership as an asset or liability in his book Rich Dad Poor Dad. Buying a property is one of the biggest costs you will undertake in your life. That and a wedding, so you want to make sure that you get it right!

1. Talk to a Mortgage Broker

Speaking to people who are industry experts is a crucial first step (and I’m not talking about property agents). Mortgage brokers are fantastic to speak to when scoping the market and some can provide a free service! A broker can provide you with a calculation of your borrowing capacity. The amount that you can borrow is required if you are wanting to take out a loan to buy your first rental property.

Living expenses are an important factor that not that many people consider when buying their first rental property. is The ability to borrow can be significantly reduced due to personal and other loans. For instance, for every $1,000 that the credit limit increases by equates to roughly $5,000 to $6,000 less borrowing power. Therefore taking out a credit card is not ideal when trying to obtain finance. So for an average credit card with a $6,000 limit could reduce your borrowing power by $36,000! This is far less than had you cut up the card and tossed it in the bin.

Working out your finances BEFORE you start looking for that ideal rental property is crucial to getting finance quickly. The cost of a good broker may set you back roughly $275 for their services and advice. However, you can access a wealth of knowledge about the property market. You may even get that fee refunded when using the same broker. Whether you buy your first property with them it pays to speak to a broker about the options available to you.

2. Ask the experts the right questions

Some of the key questions I would recommend you ask the mortgage broker are:

• What are the best interest rates on a home loan currently in the market?
• Why are some lenders’ rates higher/lower than others?
• What options are there to bundle your loan – ie. offset account?
• Should I go with a fixed or variable rate?
• What are the costs and benefits of the two rate types?
• What government incentives are available to me in my state – stamp duty exemptions, first home owner grant? Western Australian First Home Owners Grant (Grant for First Home Buyers)

3. Consider all alternatives

Owner-occupier can rent a spare room out for extra income to help service the loan. Alternatively, you may decide to rentvest (buy a rental property while renting in a nicer location). Either way, make sure you weigh up the pros and cons of your investment decision. Speaking with a mortgage broker I discovered that in Western Australia you might eligible for the first home buyer stamp duty exemption. This may even apply to buying your second property under specific circumstances. This exemption in WA is set currently on homes with a max purchase price of $430,000 for a first home buyer. Please ensure that you check your individual state laws as these vary from state to state in Australia.

The stamp duty exemption on the second property would only be available to first homeowners if they had not lived in the first rental property. Furthermore, they must never have owned any other properties previously. There are more exceptions that may make you ineligible for the exemption. Therefore, read the full terms and conditions applicable within your state legislation. This legislation does vary and gets updated over time. So it’s important you do your own research to consider your own situation.

4. Calculate your borrowing capacity

Calculating borrowing capacity or repayments can be easily done through online calculators. I used a loan repayment calculator to get an indicator of the required monthly repayments. For example, you could calculate the repayments on a cheap 2 bedroom 1 bathroom villa using the loan calculate above courtesy of Stirling Finance (WA). The calculator can provide a visual line graph of the loan balance owing and years remaining to service the loan. This would give you a great indication of the type of rental property that you can afford to buy and an overview of the estimated repayment horizon.

5. Search for the right rental property

Searching for the right rental property is a fun and exciting process to acquiring a property. First, determine your loan limit and repayments. Secondly, consider using an in-depth property research function such as the CoreLogic RP Data Professional tool. First, weigh up if the $198 single monthly fee is worth your while. Secondly, a generic real estate website such as realestate.com may suffice as it is a free search engine.

Some factors you should consider when searching for your ideal property are:

1. Location, location, location
2. Size of the block (research potential for capital growth of land)
3. Value of home relative to your budget
4. Time the property has been listed on the market

Once you have found the right property you have two options; a cash offer or subject to finance. A cash offer is more appealing to a vendor with a short time frame. Cash offers are favorable in a bidder war when competing against other offers for the same property.

6. Finance the rental property loan

Organising all contract documents is a vital step to securing finance for the property. This is where the mortgage broker and your prior planning become vitally important. You can use their expertise to lock in a great rate and smooth over all the terms and conditions of the contract. If you have a property and are considering selling it to fund you new purchase, find out what the property is worth through a free professional property appraisal. Upside can provide a fully managed sale from arranging photography and advertisements to managing inquiries every step of the way until settlement. When deciding on the right finance, make sure you first consider these five steps to secure a home loan.

7. Setup the loan repayment structure

The mortgage broker will also inform you of the different options to structure the property loan. For instance, whether you want an offset account, pay down the loan directly, or set up multiple accounts. An advantage of an offset account is the flexibility it provides for repayments. Combing an offset account and a variable interest rate enables you to change the amount you pay down on the investment loan. An offset account can also be used to acquire an owner-occupied property.

Speak to your accountant about structuring advice if considering a Family Trust or shifting funds from your offset to a new home loan. Investment loans can offer interest deductibility whereas the interest on an owner-occupied loan is not deductible. A meeting with your accountant/broker would ensure you are getting a tailored approach that suits your personal needs.

Once the contract is finalised you are the proud owner of your first rental property! Now you can join the 6 million other Australians who collectively hold $2.1 trillion of debt. You will also realise the great Australian dream of homeownership. To start recording all your income and expenses see the Wage Investor Rental Property Schedule to streamline your record keeping. If you are still weighing up the different investing options have a read of the article Property vs Shares.

For more information about the steps discussed above, I strongly suggest you first talk to your own mortgage broker. This information is general in nature, not financial advice, and could be subject to change.