Do you have an investment property portfolio bringing in some rental income? That rental income can help boost your borrowing capacity in order to secure the next home loan. Whether you’re keen to grow your portfolio or refinance what you’ve already got, understanding how lenders treat that income can make a world of difference to your borrowing power. Here’s the lowdown on making your rental income work for you.
What is Rental Income in the Eyes of a Lender?
If you have multiple properties, your rental income plays a big part in showing lenders you can service the repayments on a loan. But heads up—they’re not counting every cent of that rental income. Lenders usually take only 80% of your rental income into account, just to cover themselves for things like tenant vacancies, upkeep, and all those extra costs that come with owning property.
This is known in the mortgage world as “shading” (by 20%).
This means if your rental property generates $500 per week, a lender will use 80% of that, or $400, when calculating your serviceability. While shading by 20% creates a buffer for unforeseen costs, it also means you need to be strategic about how you manage and report your rental income.
On top of shading by 20%, lenders will also want to know what your monthly IP (investment property) costs are. Things like property management fees, council rates, body corporate, land tax and maintenance.
Kinda feels like the lenders are double dipping on costs right?
Oh, and let’s not forget, most lenders will cap the yield at 6%. What does this mean? If you have a property worth $750k, and you’re receiving $1,000 per week in rent (maybe it’s a duel occupancy property), the lender will only use $865 per week. 20% shading will still apply, so the lender will only use $692 per week.
Boosting Your Borrowing Power with Rental Income
- Provide proper documentation
To use your rental income in a loan application, you’ll need to provide proof of that income. This typically includes recent lease agreements, rental statements, and bank records showing the rental payments coming in. For the new property that you’re buying, lenders will ask for a rental appraisal from a qualified agent to estimate the potential income, and the lender will also look at what the valuation report says. The lender will use whichever is lower – valuation, or rental appraisal. - Minimise Vacancies and Maintain Consistency
A solid rental history can improve your chances of qualifying for a loan. Lenders want to see that steady income flow, so if you’ve got long-term tenants and minimal vacancies, you’re already in great shape. Showing that your properties bring in reliable income can give lenders the confidence they need to know you’ve got those repayments covered. - Boost Rental Income Where Possible
Higher rental income means more borrowing power. I know I said above that many lenders will cap the yield at 6%, thankfully there are some that don’t. If you’ve got the chance to increase your rental income —e.g. cosmetic renovation, building a 2nd dwelling on the property, or adjusting to the current market—it could help improve your borrowing capacity. - Know How Lenders Calculate Serviceability
Lenders calculate your borrowing capacity based on your total household income, which includes a percentage of your rental earnings, less expenses. It’s important to note that any costs associated with maintaining the rental property—such as insurance, management fees, and maintenance—will reduce the amount of income lenders factor into your application. Keeping these expenses low, while maximising rental returns, can help you qualify for a loan. - Consult with a Mortgage Broker
Being a broker, of course I’d say this! But srsly though, every lender has different criteria when it comes to assessing rental income, and some will be more generous than others. Working with a mortgage broker who understands investment properties can help you find the right lender who values your rental income appropriately, allowing you to borrow more.
Rental Expenses
While rental income can strengthen your loan application, don’t overlook the impact of rental expenses. Lenders will consider outgoings such as property management fees, maintenance, rates, land tax and insurance when calculating how much of your rental income will be used to assess your serviceability. This might mean that your property portfolio should be focussed on states that don’t charge (or charge minimal) land tax, and possibly looking at properties not under strata with heavy body corporate fees.
Growing Your Property Portfolio with Rental Income
For property investors, rental income is more than just cash flow—it’s a handy tool to help grow your portfolio. By using your rental income to qualify for loans, you can boost your borrowing power, making it easier to reinvest in more properties. It’s a win-win cycle, where each new investment strengthens your overall position, both in income and assets.
That said, it’s almost guaranteed that you’ll eventually run into a “servicability wall” due to the lenders buffers and shading. However if you put in place a plan of what type/s of property to purchase, in what order, then you build your property portfolio to it’s maximum potential.
Whether you’re refinancing or adding another property to your portfolio, understanding how lenders view rental income will help you make informed decisions and maximise your investment potential. Call us now on 02 6188 4555 or make an appointment for a free consultation to discuss your options.
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