How much money do you need to buy an investment property?

We’ve seen a lot of information on loan to value ratios recently. The removal of the LVR funding restrictions has meant that banks are slowly moving towards allowing up to 80 percent to be borrowed against investment properties.

So if you’re in the market for an investment property, you need to know two things. Do you have enough equity or cash as a deposit? And do you have enough income to afford the mortgage?

Perhaps the most surprising outcome of these sub-three percent interest rates is that even Auckland investment properties will probably be cash-flow positive these days meaning they should pay their own way - or may need a little top up once insurance and rates are factored in.

But unfortunately, the banks don’t use today’s interest rates when they’re assessing mortgage affordability. Instead, they put applicant income through a series of stress tests that makes sure the mortgage can be paid at a much higher interest rate. Here’s how they do it.

Let’s say you earn $20,000 per year in rental income. Most banks will scale this down to 75 percent. This allows for the costs of insurance, rates, tenant vacancies and maintenance. So the use-able income is now down to $15,000.

They then calculate what that income can afford if the mortgage is around seven percent. It’s likely the banks will consider lowering this a little (to say six percent) in the near future, but at the time of writing, most are around seven percent.

That’s significantly higher than the mid-two percent rates you’re getting at the moment. But the banks want to know that if the interest rates jump up, that you will be able to afford your mortgage. It’s not about affording your mortgage today, it’s about being able to afford your mortgage in the future.

It turns out that, roughly speaking, your gross rental allows you to borrow about ten times as much on a mortgage. In other words, $20,000 of rental income allows you to borrow around $200,000.

If you wish to calculate approximately how much you can borrow in total (including your current mortgage) here’s a great way to see if you’re in the ballpark:

- Find a property you want to buy as an investment;

- Multiply your everyday family income by five and the rental income by ten (for example if you earn $100,000 at work and receive $40,000 of rent that will be $900,000 - $500,000 plus $400,000);

- If that final number is enough to cover your current mortgage and the new property, you should consider getting an approval.

It’s a very rough calculation but is a great way to see if you’re close to affording your next investment property.

- Rupert Gough is the founder and CEO of Mortgage Lab and author of The Successful First Home Buyer.