Smart Guide to Buying your Second Property in Australia

It may seem risky, but buying a second property could set you on a path toward long-term prosperity. But it could also cause financial pain.

There's no one-size-fits-all answer on whether you should take the plunge. So, before you do, here are a few things to consider.

1. Consider the cash flow

There's no way around it - taking out a second mortgage is going to impact your monthly cash flow, even if you're planning to purchase an investment property capable of generating rental income.

Before you do anything, you'll need to assess whether you have a stable income and if you're in a position to service two home loans. Managing two mortgages is a feat in itself, but it's hardly ideal if you're just scraping by.

You'll also need to ensure you have a comfortable buffer should there be any issues ahead, such as if you were to lose your job, fall ill, or encounter other unforeseen expenses.

From a lender's point of view, the key to minimising risk lies in your ability to have enough income to service a first and second mortgage, on top of your general living costs. Do the sums yourself before applying to see whether it's going to be manageable for your circumstances.

2. Why are you buying a second property?

Be clear on what's driving you to buy a second property from the outset. Are you investing for the long or short term? Or are you looking for a holiday home? Maybe you're buying a second home in your dream retirement spot and you intend on renting it out until you can afford to spend time there yourself.

Your answer will influence important decisions such as the type of property you'll buy, the location, and how much you're willing to spend. Let's consider the two main motives to purchase a second home:

Buying a second property as an investment

If you're buying a second home for investment purposes, you'll need to do a few calculations first. Take into account your expected loan amount, repayments, and possible rental income. You can be sure your lender will be running the figures when you apply for your loan.

Our Can I afford an investment property? calculator can help give you some idea.

When you apply for a home loan, many lenders will require you to supply a rental estimate letter (sometimes called a rental appraisal or rental valuation report). This can come from a registered real estate agent or the property manager you're considering.

Keep in mind, it's unlikely lenders will count 100% of your possible rental income in your loan serviceability calculations. They generally factor in around 50-75%, allowing for rental vacancy, tenancy issues, or maintenance expenses that could reduce the income generated.

They'll also consider where the property is located and what type of property it is. To ensure this doesn't become an issue, it's imperative you choose a well located investment property that's in suitable condition to produce constant rental income to support your loan repayments.

This means looking for homes in areas with high tenant appeal and good rental returns, as well as the potential for capital growth. Also consider the property's proximity to sought-after amenities such as public transport, schools, health facilities, cafes, retail precincts, etc.

See also: How to increase your investment property's rental yield

Buying a second property as a holiday home

If you're considering purchasing a holiday home, or one you'll use only sometimes, the first thing to ask yourself is how long you plan on using the property. Will it be a regular weekend getaway or do you plan to put it on the short-term rental market as well?

It may be wise to also view a home that you'll only use occasionally as an investment opportunity. By renting out the property for shorter periods, such as through short-term rental platforms, you could potentially cover some (or all) of your mortgage payments through rental income and maybe even generate a return on your investment.

But don't forget the various costs associated with owning a holiday rental property. These include maintenance, insurance, property management fees, cleaning, linen services, and plenty more that should be factored into your financial calculations.

See also: Holiday Homes: What you Need to Know

If the short-term rental market is part of your strategy, you'll also need to get yourself up to speed with local council by-laws and strata rules surrounding holiday rentals.

There are tax considerations with second homes too. In simple terms, according to the ATO:

• If you own a holiday home and don't rent out the property, the property does not need to be included in your tax return until you sell it.

• If your holiday home is rented out, you need to include the rent you receive as income in your tax assessment.

• You can claim expenses for the property based on the extent that they are incurred for the purpose of producing rental income.

See also: What tax deductions can you claim on your rental property?

Note: There are different rules surrounding property investment for self-managed superannuation funds (SMSFs). If you're investing in a residential property via an SMSF, it's critical you understand the laws and tax implications.

See also: A complete guide to property investment through Self-Managed Super Funds

3. Do you have equity in your first property?

Using equity in your first home can help you secure a mortgage for a second.

In simple terms, home equity represents the value of your property not tied up in your mortgage. Over time, you can accumulate equity in your home by making regular mortgage payments and through increases in your home's value.

If you've built up sufficient equity, you may be able to use it as security for the loan on your second home. This can be an alternative to providing a cash deposit and potentially offer you more flexibility in financing your second home purchase.

Here's an example of how it works:

Sharon's house is valued at $700,000 and her outstanding mortgage is worth $320,000. This means the equity in her home is $380,000.

Most lenders allow borrowers to access up to 80% of their property's value, minus their outstanding debt.

So, 80% of Sharon's property value is $560,000. If you take away the outstanding debt of $320,000, Sharon is left with $240,000 of useable equity to put towards a second home deposit.

However, it's important to carefully consider the risks and benefits of using your current home equity to secure a loan, as it can put both properties at risk if you're unable to make your loan repayments. (See more on this below.)

4. Have a safety buffer in place

Using your existing owner-occupied property as security on your second loan is a popular strategy among second home buyers.

To mitigate the risks associated with potentially losing your home if you default on your second mortgage, it's essential to have a contingency fund to fall back on. It's wise - and comforting - to have a safety buffer of three to six months' worth of repayments and living expenses to prepare for any unplanned events.

A reserved emergency fund of savings will also be well regarded by potential lenders.

5. Reassess your borrowing capacity

Like any other home loan application, your second mortgage is assessed on your income versus expenses and assets versus liabilities.

That means if you have an existing home loan or other debts, such as personal loans and credit cards, your borrowing power will be less than if you were debt-free.

See also: Understanding debt-to-income ratio

But your lender will regard your borrowing credentials differently for a second home, even if you're borrowing through the same lender.

Loans for a second property are regarded as higher risk than those for owner-occupied homes as lenders believe there's a greater chance borrowers will default on a second mortgage than one tied to their own homes.

This logic also impacts interest rates. To hedge against any potential losses, interest rates are almost always higher on investment loans or second mortgages than on equivalent owner-occupier mortgages.

How can you maximise your borrowing capacity?

If your lender is offering to lend your less on a second home loan than you anticipated, you may be able to take steps to boost your borrowing power.

These include the obvious ones such as clearing existing debts, increasing your income, and reducing expenses.

See also: Helpful Guides on How to Increase your Borrowing Capacity

You might also consider applying to a different lender. Each has its own assessment criteria and lending policies, and you may find other lenders willing to approve a higher loan amount.

But bear in mind, applying to multiple lenders can have a negative impact on your credit score. Engaging a mortgage broker can be a good move in such cases as they should be able to match you to a lender willing to approve a loan to someone in your circumstances.

6. Decide on a loan type

When you take out a second loan, you'll have the choice between a variable rate, fixed rate, or a split loan. You should be across the options from your previous home loan but here's a quick refresh:

• Variable rate A variable rate home loan means the interest rate will move up or down during the loan term. This usually occurs with market movements in the Reserve Bank cash rate or at the discretion of the lender. Variable rate loans tend to be more flexible than fixed rates as they often come with features such as offset accounts, redraw facilities, and the ability to make extra repayments.

• Fixed rate A fixed rate home loan sees the interest rate locked for a set period of time, typically between one and five years. A fixed rate can be a good idea for some second homebuyers who want the security of knowing exactly what their monthly repayments will be. However, if market interest rates fall, it can be expensive to switch to a lower interest rate loan.

See also: Fixed rate home loans: Benefits and drawbacks

• Split loan With a split loan, the rate on a portion of the mortgage is variable and that on the rest is fixed. This could be a 50/50 split, an 80/20 split, or a different split entirely - whatever is agreed upon by you and your lender.

Below are some highly competitive investment property home loans for you to consider in your search:

Important Information and Comparison Rate Warning

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