Investing in Real Estate 103 (Leveraging for a Pre-approval)

Happy Australia Day folks!

To all our international friends – January’s usually a good month here in Australia, because so shortly after the New Year celebrations – there’s a three week hiatus which culminates into another party for the Australia Day long weekend.

Surely there are worse things in life than moments spent with your family and friends accompanied by yummy food and delicious wine?

That’s what makes living in this country so great, the sense of community, good living and general good vibes.

Our attitude towards real estate is pretty unique as well – the “Great Australian Dream” is ingrained in our national psyche, a generational belief that home ownership leads to a better life which reflects success and security.

So of course I had to write up a series on real estate investing – would have been unAustralian NOT to.

OK, so you’ve read the first two parts on this series, your mindset is switched on, you’ve found your why, you understand supply and demand – where to next?

Understand leverage.

Unless you are blessed with good fortune, have a complete aversion to borrowing and don’t mind hundreds of thousands if not millions of dollars tied up within a single asset – you have to borrow, you have to use leverage.

Ah leverage – you shifty bastard, what do we do with you?

Essentially, leveraging works like so:

I can put in $1 and borrow $9 to control $10 worth of assets. If the asset value rises 10% to $11 – I’ve made a 100% return (doubled) on my initial investment (less interest costs).

Conversely, the double edged sword swings both ways – if it drops down to $9, then… then… well… not ideal.

Leverage is very, very powerful if used correctly – when investing in real estate the return (income yield and/or growth) you receive compared to your initial investment is a good metric of performance.

What’s your borrowing capacity?

I’m ready TheFrugalSamurai, I get leverage, I got it, let’s go, you and me – we’ll go out and buy something today.

Wait, hang on a tic – you can’t just go out and pull the trigger on the first thing you like – it’s not Duck Hunt.

You need to understand your borrowing capacity.

Any good bank lender or mortgage broker should be able to calculate this for you.

It’s fairly straightforward.

Primarily, they take your current income, current existing loans (e.g. credit cards, personal loans, car loans, investment or home loans etc.), current living expenses, proposed rental income (if applying for investment loan), proposed investment loan(s) – whack it into their spreadsheet or banking calculator, run the algorithm and viola – out spits a number.

This number is your borrowing capacity.

Pre-approval.

At this point, the lender or broker might want to sign you up for a loan pre-approval. A sort of certificate which states that off you go – you’re good to borrow up to this amount.

WRONG.

You see, it’s only a conditional approval – conditional based on every figure you provided being accurate, based on there being no issues with your future property, based on future valuations stacking up, based on no changes to your future circumstances.

My personal opinion is that a pre-approval is there so you feel committed to the lender or broker.

Why?

Because come the actual negotiations when making an offer on a property, majority of cases you would request a finance clause, i.e. subject to the lender allowing you funds to borrow to complete the purchase.

Then you go through the formal loan application process to receive an unconditional approval.

Also, a pre-approval is recorded as a hit on your credit score, i.e. your credit worthiness to a future lender. Each time you request credit – credit cards, personal loans, car loans etc. it is recorded and affects your score (future borrowing capacity).

Too many credit hits in too short a time – the lender would look at you funny and ask:

Ideally, you’d have your credit score as clean as possible.

That’s why I think any bank lender or mortgage broker worth their salt should be able to tell you what your borrowing capacity is fairly well.

Far out, OK TheFrugalSamurai – I know my borrowing capacity now, can I buy something yet?

I won’t stop you! I’m just trying to share what I’ve learnt on my journey – whether it’s valuable or not is up to you!

OK, OK fine. What else do I have to know?  

Oh plenty, the ownership structure, cash-flow strategy, tax considerations, where to start researching, how to make offers, who should be on your team, what type of property… sigh… so much to know… BUT never fear – I’ll be here.

That’s… that’s what I’m afraid of.

… Fuck you.

Internal dialogues aside, I hope you have enjoyed the real estate investing series so far, it’s set to be a long and hopefully insightful journey.

I’m going to be sharing a couple of my own personal experiences on this path as well – stay tuned!

What do you think? Did you enjoy this post? Please help me out if you enjoyed this and click on the little “follow” button at the bottom right and be a follower. This way, you’ll never miss my words of awesomeness!

P.S. As always, the posts are opinions and thoughts of yours truly only – always, always do your own research before making any decisions, remember that every person’s circumstances is unique so there’s no right or wrong way of going about it!