Residential Income Assessment - Leveraging property cashflow

A question I'm often asked; is how banks treat rental income? Do they include it in their servicing calculations in determining how much I can borrow?

Yeah, they do.

Most lenders will allow for 75-80% of a property's rental income, less body corp fee if there is one in their servicing calculation. The scaling back is their allowance for the related expenses, which they typically don't include, except the body corp fee.

The key income ratio lenders are looking at for individual investors is their UMI or simply put your income statement. It's what you earn (including rent), less what you spend, less what the proposed loan is going to cost you to service over the loan term, on the lenders sensitised interest rate.

As the loan interest on the sensitised rate plus amortisation is typically higher than the scaled rental income, the new property purchase generally weakens your UMI or borrowing capacity.

To work out the required rate of return for a property purchase not to weaken your borrowing capacity, you simply divide the annual loan repayments (based on the loan term and sensitised interest rate) by the rental income scaling (75-80%) and divide by the property value. Gives you your required gross rental return for a self-servicing property.

Example:
Value: $1,000,000
Loan: $1,000,000
Loan Term: 30 Years
Sensitised Interest Rate: 6.5%
Annual Loan Repayments: $75,852
Rental Scaling: 75%
Required Rent: $75,852 / 75% = $101,136
Required Gross Return: $101,136 / $1,000,000 = 10.11%

As your property portfolio grows, your rental income might surpass your salaried income (hopefully) or you might accumulate enough properties the lender treats your activity as a rental accommodation business.

It's an important time to reassess your debt structuring and financing strategy at this point.

If you're just starting to invest or looking to grow your portfolio, it's important to be clear on your objective, and understand the mix of income and capital properties that will help you get there, and how you'll finance them.

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