Would renting out your home help you to grow an investment portfolio?

To demonstrate this, imagine if Geoff and Sandra own their principal place of residence (PPOR) worth $1 million with an $800,000 loan, would their overall borrowing power increase by renting the apartment next door for $650 p/w and turning their place into an investment which rents for $650 p/w?

Running the numbers, Geoff and Sandra won’t experience any material rise in their borrowing power from doing this. With some lender calculators, they will receive a benefit, but with most, the impact will be negligible/negative. This is because of the way lenders assess the combination of rental expense, rental income, and mortgage debt for servicing. Considering the following:

• Their new rental expense will be included at 100 per cent, so a $650 p/w rental expense is taken at $650 for servicing.
• Their new rental income will be included at only 80 per cent, so $650 p/w rental income is haircut down to $520 for servicing.
• The $800,000 debt turns into investment debt. Banks will apply the same buffers for this mortgage as if it were for a PPOR - ‘expensed’ at 7.25 per cent P&I repayments over 25 years (5 year I/O period). However, this debt with now be considered in their negative gearing calculation as it is now investment debt.

The combination of these factors produces a range of different results depending on exactly how the servicing calculator of each bank works.

Generally speaking though, the servicing benefit of the loan into investment debt is not enough to make up for the difference between their rental expense of $650 and their haircut rental income taken at $520.

This is why with most servicing calculators, there will be negligible servicing benefits to switching your existing PPOR to an investment property.