Understanding finance is necessary in order to successfully build a property portfolio. Finance or lending is simply the funding used in order to purchase a property. The majority of investment properties are financed by a lender (bank) who lends money to the investor. While finance is a critical step during the purchasing process as it ensures the buyer has the fund to complete the transaction of a property. Knowing this, to build a property portfolio an investor needs to understand finance and how to optimally utilise lending to meet their goals and circumstance.
Importance of Finance
The importance of finance in building a property portfolio cannot be understated. To build a significant property portfolio you need cash flow, there is no other way around it. Your cash flow can be derived from your income which encompasses your job, rental income, or other assets. By using finance, an investor can use their borrowing capacity to leverage their income. This allows the investor to purchase assets which they wouldn’t be able to buy themselves. Without finance, investors can become stuck unable to purchase more property.
Changes to Lending
Within recent years banks have tightened the restrictions on lending making it even harder to build a substantial portfolio. Therefore, it is critical to consider how you are going to build your portfolio whilst minimising any financial hurdles. Understanding finance and lending restrictions will enable the investor to maximise their borrowing capacity.
To give you an idea of current borrowing restrictions, a general rule of thumb (currently) is that you can borrow six times your income plus seventy percent of your rental income. For example, if you earn $100k a year and plan to purchase a property which rents for $500 per week the following calculations would apply: 100,000 x 6 + 500 x 52 x 0.7 = $618,200. Therefore, you would be able to borrow approximately $620k. As your income changes and you purchase more property your borrowing capacity may increase. (Please note, this is general in nature and by no means reflective of your own situation).
To continue to progress in building your portfolio an investor always needs to be thinking a couple of steps ahead. In doing so an investor can determine where they may hit the wall in their serviceability. Understanding finance and thinking ahead helps to highlight what approach you can employ when purchasing a property. By constantly assessing, evaluating, and calculating your position you can avoid roadblocks along the way. Consider how each purchase within your portfolio will impact your serviceability. Cross-reference this with your goals to determine what approach you need to take to strive towards your overarching aim.
For many investors, the trickiest part of purchasing a property is ensuring you have correctly organised finance. When looking to obtain finance an individual can either deal with a bank or a mortgage broker. Both have the ability to assist in obtaining finance. However, the approach they take and the strategy they employ can be vastly different. A mortgage broker can be used by an investor to assist in obtaining lending and planning for future purchases. They create a plan and think numerous steps ahead to ensure you are able to execute your investment strategy. This is one type of professional an investor may want to consider adding to their property team.
Understanding finance before diving into building your portfolio will allow you to work within your parameters as set by lenders. Gone are the days where you can just purchase without any limit or restrictions. Should lending change in the future then your approach may also need to change with it, however, it is highly unlikely lenders will have no lending restrictions at all. So, it is important to understand finance by knowing where you sit within your capacity to borrow and how you may service your portfolio best.