Why rentvesting may be the answer to building a larger portfolio
Many investors are unaware that renting versus owning your own home are treated different by the banks when they test your servicing, and the results may surprise you. Where does rentvesting fall into this?
Traditional thinking about how to get ahead has typically involved buying your own house and paying it off slowly. This can work very well – you have a place of residence and asset values could rise over the long run. So why not own the asset you live in?
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The answer is that it may actually reduce your ability to grow an investment portfolio compared to someone renting. Let’s explore further.
Owning your own home may reduce your borrowing power to build an investment portfolio. The borrowing power reduction will be larger if you live in a more expensive city where property yields are lower.
This is best demonstrated in the example scenario, as stated below.
Harry and Steff are Sydney professionals deciding between two options:
- buying the inner city apartment they live in for $1 million with a 20 per cent deposit; or
- continue renting the same apartment for $650 p/w (3.5 per cent yield) and investing their deposit elsewhere.
Harry and Steff work out their interest-only repayment on their $800,000 owner-occupier mortgage is around $615 p/w. They add in $50 a week for the other property costs and get to a weekly housing expense figure of around $665 p/w. They think this is a great option as owning will cost a very similar amount to renting.
However, Harry and Steff also want to build an investment portfolio and decide to seek advice on what the impact of this decision will have on their future borrowing capacities.
Banks work out their serviceability in each scenario:
- Their $800,000 loan gets ‘expensed’ at 7.25 per cent P&I repayments over 25 years (5 year I/O period). This equates to a $69,384 yearly expense that is included in most serviceability calculators going forward.
- That is their housing expense actually works out to be $1,334 p/w according to the banks.
- If they decide to rent, the $650 p/w, the bank will apply no additional buffers and no additional loading.
- That is, their housing expense is $650 p/w.
In this example, Harry and Steff’s future borrowing capacity for an investment portfolio is about $420,000 better off by renting than owning. They still live where they want to, but can now borrow far more from the banks to grow their investment portfolio.
As you can see, for investors looking to grow a portfolio renting actually gives the better borrowing power numbers. This isn’t to say that renting is a better option for investors full stop, but that you should consider this impact if your goal is to grow a large portfolio. That way you can make an informed decision with a more complete information set, hopefully ensuring the decisions you make are better aligned to your long-term objectives.
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