As someone who’s bought her first home, it can be difficult to work out when the best time is to buy the second one. For my partner and I, purchasing our first home was such an exciting time that we immediately thought about what our next property would be and how we’d be able to afford it.
While I know that’s probably a far-fetched thought to have so soon, it’s important to consider what you’d need before stepping into the property market once again.
So, if you’re ready to jump back on the bandwagon for round two, here’s everything you need to know to help determine if you’re ready to take on a second mortgage.
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The 5 things you want to consider before buying your second property
It’s not ideal to purchase a second property on a whim without looking at all the facts.
ANZ Private Banker Daniel Smallwood said one of the first things lenders will look at is the reason behind the purchase.
“Lenders will first seek to understand why you’re considering purchasing a second property,” Mr Smallwood told Savings.com.au.
“Is it to create a secondary source of income? Is it to have a family move into the home? Lenders will want to know your reasoning.
“They will then look into the statement of position in relation to equity, savings, and income streams as well as potential investment income streams from the new purchase.”
Do you know why you’re getting a second property?
What’s the main purpose for your second property? Are you after a holiday home, an investment property, or looking to move into your dream home for your growing family?
Having a clear understanding of what you’re after will help direct important decisions such as the type of property you’ll buy, the location, and how much you’re willing to spend.
According to 2019-20 data released by the ABS, one in five Australian households (21%) own property besides the one they’re residing in.
This includes those that own investment properties and/or holiday homes.
67.5% (1.36 million) owned one property (besides their current place of residence)
20.4% (411,600) owned two properties
7.7% (155,200) owned three properties
4.3% (87,100) owned four or more properties
A holiday home is great for an escape - there’s no better place to wind down and relax.
But before you commit to purchasing a holiday home, there are a number of things to consider.
How long you plan on staying at the holiday home
Will you only use the holiday home occasionally or as a regular weekend getaway? Do you plan on renting it out for short term periods or during peak season when you’re not there? If you’re planning on visiting occasionally, it may be worthwhile to consider the home from an investment perspective - that way you can rent the property out for months at a time e.g. through Airbnb. Essentially, the rental income may cover part of or the whole mortgage repayment. This way, you could potentially generate a return on the holiday home.
There are extra costs to consider
Rental manager, maintenance costs, insurance to cover any damage to your property by tenants, and also insurance that covers natural disasters e.g. flooding from rivers or the sea, particularly in coastal areas.
Location and type of holiday home
Choose a location that has high rental yields with all the ‘must haves’ holiday goers are looking for such as beach views, and proximity to restaurants, shopping centres, cafes, and tourist hotspots.
If your holiday home is left vacant during the off season (i.e. unable to earn rental income) you will need to maintain the costs of two mortgages. This is especially tough if you’re relying on rental income to pay off the mortgage.
According to the ATO:
If you own a holiday home and don't rent out the property, you don't include anything in your tax return until you sell it.
If your holiday home is rented out, you need to include the rental income you receive as income in your tax return.
You can claim expenses for the property based on the extent that they are incurred for the purpose of producing rental income.
No matter whether you do or don’t rent out your holiday home, you’ll likely have to pay capital gains tax when you sell the property or transfer it into someone else’s name.
If you’re ready to start investing in property, here are some things to think about before you join the ‘investor club.’
Lenders only take a portion of your proposed rental income into account when going over your loan application.
You must consider all the hidden and long term costs involved with purchasing an investment property e.g. maintenance repairs, land tax, insurance, body corporate fees, and many more.
Choose a location that will have high tenant appeal, good rental returns, and potential for capital growth. Investors should look for areas with a long history of strong capital growth that will continue to outperform the averages because of the area’s demographics. Capital growth refers to how the property appreciates in value over time, and it’s also a key way investors build wealth, so it’s crucial in an investment property.
Ensure the location you choose is in close proximity to lifestyle amenities like cafes, shops, restaurants, parks, good schools, and public transport.
Read More: What makes a good investment property?
Do you have considerable equity in your first property?
Using equity from your first home can be powerful for anyone looking to purchase their second property. Essentially, equity in a home is the value of the property minus how much you owe on the mortgage tied to it.
Let’s look at it in a much simpler way.
John’s house is valued at $600,000 and his outstanding debt is $250,000. This means the equity in his home would be $350,000. However, most lenders generally allow borrowers to access up to 80% of their property’s value, minus their outstanding debt.
Given this, in John’s case, 80% of his property’s value ($600,000) is $480,000. Take away his outstanding debt of $250,000 and he’s left with possible available equity of $230,000 which he could use towards a deposit for his next property purchase.
“Borrowers need to be aware of the loan-to-value ratio (LVR) they will put themselves under when purchasing a second property,” Mr Smallwood explained.
“Anything over 80% will put them into Lenders Mortgage Insurance [LMI] territory, ultimately costing them more.”
Essentially, to draw equity from your loan, you can bring your debt up to an LVR of 80% without incurring specific requirements and costs.
If you’re considering going down this route, you may have a better chance of obtaining access to equity from your lender if you’ve maintained your property or completed home renovations. This is because it’s highly likely your lender will request a revaluation of your property - usually at the cost of the borrower.
Also, you can’t forget about all those extra payments like stamp duty and conveyancing.
If you’re wanting a rough gauge of how much equity is in your home, head to Savings.com.au’s equity calculator (that’s where I’ll be right after I finish writing this article).
So the ultimate question you should ask yourself is - “Have I built up enough equity in my current home?”
Read More: How to use equity to buy a second property
Is your income and savings higher than before?
Just like your income and savings pot mattered the first time round you applied for a home loan, it still does the second time.
You want to ensure you have a steady income to be able to afford two mortgages. Consider your living costs to work out whether a dual mortgage is financially viable. It’s all well and good to be able to afford two mortgages, however you don’t want to just skim by. You should have a comfortable buffer zone to weather any storm that may come your way e.g. your second property is left vacant and you need to cover the repayments/costs.
Mr Smallwood said banks and lenders will always look at whether your income has increased since the last time you took out a loan.
“This is to ensure we use accurate data at the time of servicing,” he said.
If you’ve gotten a significant pay rise and you’ve been steadily saving since your first property, then you might be ready for the second.
Remember, two properties = double the risk and double the cost.
Are property prices trending down?
While the market shouldn’t be the only factor dictating when you should buy (you have to consider your individual situation), it can be beneficial to buy your second property when house values are falling.
Property Buyers Agent Shane Strong said there are two main reasons why people should consider buying a house when prices are slumping.
“There are less buyers in the market, which means less competition and this gives you more time to research the property and the location and understand the pros and cons before jumping in,” Mr Strong told Savings.com.au.
“Additionally, sellers are more motivated to negotiate and lower their price for fear of missing out [FOMO], or more specifically in this scenario, the fear of losing money if their property takes longer to sell and the market continues to drop.”
When speaking with his clients, Mr Strong always says if you’re buying for the long term and can endure interest rate pain, then now is the time to buy.
“Once the market turns, I feel it will turn quickly and that is when buyers will start to miss out again.”
Do you have too much debt?
If you’ve said yes to all of these questions or even just the one, this may reduce your borrowing capacity and ultimately your chance of being approved for a second mortgage.
“When considering an applicant's borrowing power, we look into the income streams versus the expenditure so debt always plays a part in the calculations of a purchase,” Mr Smallwood said.
But your existing debt isn’t the only thing to worry about - rising interest rates play a big part too.
While you may be able to afford a 4.5-5% interest rate, you have to consider the possibility that rates may rise to 6% or more. Would you still be able to afford the repayments? Plus all your debt?
When lenders assess your loan application, they will factor in your ability to repay the loan at a higher interest rate. Lenders assess borrowers’ ability to meet their loan repayments at an interest rate that is at least 3% above the loan product rate. So, if the loan product was 4.5%, the lender will make sure home loan applicants can repay their mortgage if rates rise to 7.5%. Although the lender calculates this for you, it’s also something you should take the time to think about from your end.
Before buying a second property, consider your outstanding debt and whether it’s worth taking on another mortgage (financially and emotionally).
Savings.com.au’s two cents
If you’ve read this article and are confident you’re ready to buy your second property - congratulations and hats off to you!
Or, if you think you might need to take some time and assess your income or wait for your home to build more equity, that’s okay too.
Lenders consider an abundance of different factors when you apply for a second home loan (including equity, income and debt) so it’s important to be certain that you’re committed to hop onto the property market once again.
As Mr Smallwood says, “Don’t over extend yourself and just be patient.”
Image by Seb. via Unsplash
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