{"id":169884,"date":"2024-07-30T12:30:49","date_gmt":"2024-07-30T02:30:49","guid":{"rendered":"https:\/\/propertyupdate.com.au\/?p=169884"},"modified":"2024-10-05T04:47:54","modified_gmt":"2024-10-04T18:47:54","slug":"to-what-extent-does-rental-yield-affect-your-borrowing-capacity","status":"publish","type":"post","link":"https:\/\/propertyupdate.com.au\/to-what-extent-does-rental-yield-affect-your-borrowing-capacity\/","title":{"rendered":"To what extent does rental yield affect your borrowing capacity?"},"content":{"rendered":"

The very first article that I wrote for a magazine was published 21 years ago!<\/p>\n

No wonder I feel old.<\/p>\n

The article<\/a>\u00a0was called \u2018Unlimited finance\u2026\u2019.<\/p>\n

My thesis was that investing in high-yield properties doesn\u2019t magically extend ones borrowing capacity allowing them to invest a lot more.<\/p>\n

\"Khestates<\/p>\n

Some investors believe targeting high rental-yielding investment properties will allow them to borrow a lot more and therefore buy more properties.<\/p>\n

And the more property they hold, the more wealth they accumulate, or so their theory goes.<\/p>\n

However, the truth is that borrowing capacity isn\u2019t that sensitive to rental yields.<\/p>\n

How much does rental yield affect borrowing capacity?<\/span><\/h2>\n

I wrote a\u00a0blog <\/a>\u00a0highlighting that borrowing capacity is probably the tightest that it\u2019s been in 20 years.<\/p>\n

The reason is that lenders must add a benchmark interest rate of 3% on top of the actual rate you will pay to ensure you can afford a loan, should interest rates rise further.<\/p>\n

Banks will also base their affordability on principal and interest repayments over a 25-year loan term.

<\/div><\/p>\n

As such, the benchmark repayments for a $1 million investment loan will be $93,000.<\/p>\n

Consequently, for an investment property to be borrowing capacity neutral, it must generate a gross rental yield of over 13%, as most lenders shave off 20-30% of rental income to allow for expenses.<\/p>\n

Obviously, there aren\u2019t a lot of residential properties yielding more than 13%.<\/p>\n

As such, even higher-yielding investments (e.g., 4-6% p.a.) eat into investors borrowing capacity.<\/p>\n

Lower-yielding properties reduce your borrowing capacity by 25%<\/span><\/h2>\n

I spoke to an investor recently that had invested in 3 properties.<\/p>\n

The aggregate value of these properties was $1.2 million, and the portfolio had $1 million of debt.<\/p>\n

The gross rental yield across the portfolio was around 5.2% p.a.<\/p>\n

This investor thought targeting high-yielding properties would allow him to borrow more and buy more properties.<\/p>\n

\"Rental<\/p>\n

It is true that higher-yielding properties do increase your borrowing capacity.<\/p>\n

Let\u2019s look at an example.<\/p>\n

I assumed each spouse earns $100k p.a. gross, has an outstanding home loan of $350k, spends $5,500 per month on living expenses and has a credit card with a $5k limit.<\/p>\n

Based on these assumptions, I calculated their borrowing capacity as follows:<\/p>\n