You may be thinking about buying a second property. Perhaps you want to make sure your parents have somewhere to live as they get older. Or, you may be thinking about becoming an investor.
Whatever the case may be, there’s a lot of risk attached to buying more real estate. We’re going to cover the things that you need to know before you buy a second property.
The Initial Things to Consider
Before you start thinking about applying for a new home loan, there are several things you must consider.
Failure to think about these issues could lead you into financial difficulties.
Issue #1 – Your Current Cash Flow
Think about how much you earn each month. Can you cover your current home loan repayments comfortably? If you can’t, then investing in a second property may not be the best choice.
Remember that you’ll be responsible for repaying two home loans, which could double your monthly outgoings. Furthermore, your lender will need to see that you can make the extra repayments. If they don’t like what they see, you won’t be able to access a home loan for the second property.
Issue #2 – Your Backup Plan
What happens if you lose your job? Will you be able to cover the repayments on two mortgages if your financial situation changes?
The point of these questions is to highlight the importance of a backup plan. You need to have a way to cover your repayments if something goes wrong. For example, you could open a new account and store six months’ worth of repayments in it. This will give you some leeway if your regular monthly income falters.
Issue #3 – Your Rental Income
You have to be able to estimate your monthly rental income if you’re buying the second property as an investment. Work with a real estate agent to find out what you need to know. Most can provide letters that estimate the amount of rent your new property could command. In fact, your lender may ask for this letter when you apply for a home loan.
You must also remember that lenders generally only take a portion of your proposed rental income into account when examining your application. This means that you can’t always rely on the rent your second property generates to access a large home loan.
Choosing a Home Loan
Once you’ve covered these issues, you can start thinking about your home loan.
On the basic level, you have a choice between a fixed-rate or variable loan. If rates have fallen, it may be best to try and lock the rate for your second mortgage for as long as possible. This means you’ll pay less interest if the interest rate rises again.
However, you need to remember that most lenders attach exit fees and break costs to their fixed mortgages. If the second property doesn’t work out, you may have to pay a lot of money. As a result, you may find a variable rate loan more attractive just because it offers more flexibility if you find out that you can’t afford the property after you’ve bought it.
Applying for Your New Home Loan
You’ll go through a similar process when applying for your second home loan as you did for the first. This means that your lender will reassess your financial situation to ensure you’re able to keep up with the repayments.
Your current loan, plus any personal loans you have, will lower your borrowing power. However, you can counter this if you offer a sizeable deposit and you can command a high rent for the property.
Investors usually can’t access second home loans that are worth more than 90% of the value of the property.
The reason for this is that lenders see investors as presenting a higher risk than owner-occupiers. This is because investors don’t have the same attachment to their properties as owner-occupiers. If something goes wrong, an investor can walk away. An owner-occupier has to stay and fix the issue – otherwise, they lose their home.
In addition to this, you have to bear in mind that your lender will look at a second home loan application in detail. Defaults on your credit record will thwart your attempts to get a loan. Lenders are also stricter about issues like late repayments of your other debts. As such, you need to make sure you’ve been paying your other debts on time and in full before applying.
Can I Boost My Borrowing Power?
Before you try to boost your borrowing power, you have to understand why a lender may not offer the amount you want. Your lender may offer you a lower loan amount because they think you’ll end up in financial trouble if your loan has a high LVR. This means you need to be honest with yourself about whether you could afford a higher loan.
You have some options if you want to access more money. The simplest is getting rid of your existing debts. Pay off your personal loans and credit cards, as this frees up money that you could use for the home loan repayments.
Also, remember that each lender has different criteria for approving a home loan. A major bank may be more cautious than a specialty lender. This means you might be able to access more money from a smaller lender.
However, you should try to avoid lodging several home loan applications in a short space of time. Each application goes onto your credit report as an “enquiry”. If you have too many enquiries in a short space of time, many lenders will refuse to let you borrow money from them.
Can I Use My Equity?
You can, assuming you have lived in your first home for a sufficient amount of time. Ideally, you’ll have been there for at least five years, as this allows enough equity to build in the property.
You can use this equity to put down a larger deposit for your second home loan, which will make your lender more likely to approve your application. However, your lender will also want to revalue your current property before offering you access to your equity. Make sure you keep the property in good condition before this revaluation. It may help to give old walls a lick of paint, for example.
Who Should I Refinance With?
If you decide to refinance, you need to decide whether you want to go with your current lender or a new one. Remember that home loan products change constantly. A new lender may be able to offer better interest rates or more attractive features. However, your current lender may have also introduced new products.
At the very least, you should check your current mortgage against the new products that are available. This will help you to stack up what you are paying against the type of loan you could access through another lender. If you can lower your monthly repayments, for example, it may be worth refinancing your loan. This might also free up the money you need to put towards your second home. But remember that you could use what you learn as leverage. Your current lender may offer a better rate if you tell them you’re considering moving to a competitor.
It’s wise to speak to a financial advisor first. This will help you to nail down your goals, as well as give you a better understanding of your financial strength. You should then work with a home loan consultant to find out what products are available to you. Our mortgage brokers can help you work out if refinancing is the right choice for you.
What Are the Costs of Refinancing?
You’ll probably have to deal with a lot of fees if you decide to refinance to access your equity. First, you have to think about the fees your current lender may charge. You may have to pay additional break fees if you try to leave a fixed-rate mortgage, for example. Bear in mind that you might avoid some of these fees if you refinance with your current lender.
After that, you need to consider the costs of setting up a new mortgage. Home loan establishment can cost up to $1,000. Furthermore, you may have to pay Lender’s Mortgage Insurance (LMI) if you borrow more than 80% of the home’s value. You also have to consider conveyancing fees and everything else that goes into getting a new home loan.
Generally, you should be in a position where you can earn back the costs of refinancing within 12 months of doing it. This is especially the case if you use the money to buy a second property, as you now have a second mortgage to consider.
Should I Get a Professional Loan Package?
Most lenders will offer professional packages if you refinance your first home to buy a second property. These “pro packs” offer more features than basic home loans, which may prove useful when it comes to repaying your new mortgage.
Pro packs tend to come with either annual or monthly fees, which usually amount to between $300 and $400 per year. In return, you get several discounts on other products. Furthermore, this fee covers many of the other fees that you may have had to pay for your home loan.
So, while that annual fee may seem like a lot, you can recoup your losses if you take advantage of the extra features and discounts that a pro pack offers. However, this only applies if you’re borrowing a large sum of money. A pro pack may not be the right choice for you if you borrow less than $250,000.
The features that come with a pro pack depend on the lender. In general, you usually get access to the following:
- Discounts for, or free access to, home loan features
- Waived annual fees for the lender’s credit cards
- A discounted interest rate for your home loan
Do not take the decision to apply for a pro pack lightly. Always speak to a home loan consultant to ensure a pro pack is right for you. When used correctly, a pro pack could save you up to 1% on a variable rate loan, plus savings from the other discounts.
What about a Variable Rate Loan?
Many second home buyers choose standard variable rate loans, especially if pro packs don’t suit their needs. For example, buying a home for another family member doesn’t always create the need for a pro pack. You can still make extra repayments, plus you’ll have access to extra loan features. However, you will have to pay fees for the latter that a pro pack might waive or reduce. Even a basic variable rate loan may offer enough features to justify its use over a pro pack.
Investors can also consider variable rate loans instead of pro packs. As mentioned, they can still access extra facilities. Furthermore, investors can deduct some of their interest payments from their tax bills. A pro pack doesn’t restrict your access to these tax benefits, but you don’t need one to access them.
Should I Avoid Fixed-Rate Home Loans
We’ve covered some of the disadvantages of fixed-rate home loans for those buying a second home. To reiterate, you’ll have to deal with the following:
- Exit fees and break costs if you decide to end the loan early
- Limited access to other home loan features, such as the option to make extra repayments or full offset facilities.
You also have to consider the potential benefits, though. For one, fixing your interest rate at the right time can lead to you paying less than you would with a variable rate loan. This can prove useful if you’re certain that you’ll keep your second property for a long time.
You can also pay a lock-in fee when you agree to a fixed-rate loan. This ensures that the rate you pay is the one that was offered at the pre-approval stage, rather than whatever the rate may be when you settle the loan application. It’s an extra charge, but you could save a lot of money if the rate increases in the time between pre-approval and settlement.
What to Do Next
As you can see, there’s a lot to consider when you want to buy a second property. You have to think about how you’ll get the funds for the purchase and what home loan products suit your circumstances. We recommend that you do the following before you start searching for new properties:
- Work out if refinancing will give you access to the money you need to buy a second property
- Talk to one of our mortgage brokers about your options.
This information is general in nature and you should always seek professional advice when making financial decisions.