Can I afford an investment property?

Wondering 'How much do I need to buy an investment property?' Or you're keen to invest in property, but not sure of the steps and costs involved? The first piece of good news is: it may be more affordable than you think to own the property. With a tenant paying the majority of your expenses for you, the cost of owning the property can be really manageable.

The second bit of positive news? If you own your own home already, you may be able to use the equity as a deposit on your investment property.

But with potential rewards come potential risks. As an investment property owner, you have to have good money habits, a decent pool of savings and a clear budget, so you don't run into financial trouble along the way.

Working out whether you can afford an investment property really boils down to your priorities: Are you ready to sacrifice your UberEats and weekends out now for a stronger financial future? We're here to help you work this out.

Questions you must ask:

How much does it cost to own an investment property?

Here's a list of the expenses you need to be aware of if you decide to become a property investor:

• Deposit. You'll usually need a deposit of 20% of the property's value. You are able to buy a property with less deposit, but there is a cost in the form of lenders mortgage insurance (LMI). Many people see LMI as a negative, but it can be a great tool for smart investors. Here's an example of how to use LMI to your advantage. Take your 20% deposit, which may be used to buy one investment valued at $600,000. By paying LMI you're able to split your money into two 10% deposits, to purchase two $600,000 investment properties. You now have a portfolio valued at $1.2 million, which tenants are helping you to pay off. Shop around and compare loans, as you may be able to find a mortgage with a loan-to-value ratio (LVR) as high as 95%, meaning you'll need a smaller deposit and you are able to build your portfolio at a much faster rate.
• Loan costs. In addition to repaying the interest and principal amount you borrow, there are other costs associated with your loan. There are establishment and bank application costs to consider, as well as valuation fees and monthly or annual fees, plus lenders mortgage insurance (LMI), if you are using less than 20% deposit. It's important to budget for these, but your lender will provide you with a full overview of all costs during the loan application process.
• Purchase costs. There are other costs associated with the property purchase that you'll need to consider, such as stamp duty, the amount of which varies from state to state and is based on the price of the property. You'll also need to consider the cost of the legal transfer of ownership, registration fees and the cost of a solicitor or conveyancer. Building and pest inspections should also be conducted before the sale of the property goes through, which generally cost around $500. Title searches may be another added cost.
• Investment adviser's fee. An increasing number of investors are using investment advisers or buyer's agents to help them find and purchase the right property. There is a cost to using this service, but many are willing to pay it in order to reduce the risk of buying an investment property that doesn't grow in value. Keep in mind that if you use a professional to help you buy an income-producing property asset, their fee should be tax-deductible.
• Insurance. Building insurance can protect your investment property against fire, storms, theft and a wide range of other risks, while Landlord Insurance provides cover if tenants damage your property or default on their rent. The cost of this type of cover is influenced by a range of factors, including the size of your property, the material used in its construction and where the property is located.

• Property management fees. You can manage your investment property yourself if you have the time and knowledge, but this is not recommended. Investing should be enjoyable, so most people choose to employ a professional property manager to look after their investment home. Property managers perform duties such as sourcing and screening tenants, holding open houses, and organising any repair or maintenance tasks that need to be completed. As a general guide, expect to pay around 7-10% of your rent in property management fees.
• Repairs and maintenance. Over time, your property may need repairs. Taps will leak, fittings and fixtures will need to be replaced, and some features of the house or apartment will simply break down due to general wear and tear. You should be prepared to meet the cost of any repairs and maintenance that need to be carried out at the property. Plumbers, electricians, builders, and a range of other trades may need to be called upon to keep your property in tip-top shape. Repair and maintenance expenses are generally lower on newer properties as they are less likely to have parts break down.
• Strata fees. If you buy a townhouse or unit, you'll pay ongoing body corporate fees. These fees cover the cost of building insurance and expenses associated with maintaining common areas, and they vary depending on the size and type of the building, where it's located and its features. Don't forget to examine the strata fees you'll need to pay before you make the decision to buy a property.
• Council rates. Check with the local council to find out the average quarterly rates in the area for a property of the same size as yours. Factor this amount into your budget to help you calculate the potential return on your investment.
• Other costs. Depending on your individual circumstances, other costs you may need to consider include:
  • Accountant's fees to help you calculate rental income and expenses when filing your tax return.
  • Pest control expenses.
  • Costs incurred when a tenant moves out and you need to find a new one.
  • Renovation costs if your property is due for an upgrade to increase its "liveability" and make it more attractive to prospective tenants.
  • Travel and accommodation expenses if you need to travel to inspect your property or oversee maintenance.
  • Land tax payable to the government on your investment property.
  • The cost of connecting all the utilities and services to your property for tenants.
  • Agents' fees, legal fees, advertising costs and other expenses to ensure the property is in top condition.

Tax deductions on property expenses

So far we've outlined a number of expenses, which may have you worried that investing in property is far out of your reach.

What we have outlined here is a comprehensive list of property expenses – think of it as the worst-case scenario. Some of these expenses may not be a problem for you; for instance, if you own an apartment and pay strata fees, you might also benefit from cheaper landlord and building insurance.

The great thing about investing in property is that most of these costs are tax-deductible, which means they reduce your taxable income. You may also be able to benefit from depreciation, which is a tax deduction that reduces the amount of tax you pay even further.

As a very simple calculation, let's assume that your interest-only investment mortgage is $2,000 per month. Other costs, such as property management fees, strata fees and insurance, add another $500 per month.

You receive rent of $2,500 per month, and a depreciation deduction of $7,000 per year, or just under $600 per month.

• Mortgage interest repayment $2,000 + monthly expenses $500 = $2,500 cost per month.
• Rental income of $2,500 per month cancels out all ownership expenses, so the property costs you $0 per month to own.
• Depreciation of $7,000 per year is deducted against your income tax when you do your tax return.
• Depending on the tax rate you pay, you receive a tax refund of 19-45% at the end of the financial year. This amounts to a tax refund of between $1,330 and $3,150.

How to get a loan for an investment property

Once you've decided that an investment strategy is a great idea to advance your long-term financial plan and you feel you can afford your mortgage and expenses without it negatively affecting your lifestyle, you then have to figure out whether the bank thinks you can afford an investment property.

Banks mainly want to confirm that you can afford the loan and that you are responsible with money. This is where high credit cards and personal loans, or spending habits around excessive shopping and gambling, can negatively impact your home loan application.

It's highly recommended that you aim to trim your spending for 3 to 6 months before applying for a home loan, so you can get your finances in the best possible shape.

Anything you can do to reduce your spending can help improve the chances of your home loan application being approved. Here are a few suggestions to get you started:

• Review your recent spending. Start tracking this via an app, such as the Finder app, if you aren't already. Identify areas where you are spending too much and see if there are any obvious ways you can cut down.
• Make a budget. Once you've reviewed your spending you can start to set a realistic monthly budget. Having a budget written down should hopefully make it easier to follow through and actually spend less.
• Streamline expenses. Look at those small, ongoing monthly costs such as streaming service subscriptions and memberships. You might be better off rotating between services rather than, say, paying for four TV and/or music subscription services each month.

Calculating your serviceability

Often the banks will use the word serviceability when talking about loan amounts. Use the calculator below to see how much you could potentially borrow.