Stories of asset rich, cash poor investors are common. Even investors with multiple-property portfolios can struggle to generate a deposit to buy again, especially if they’re negatively geared. Having a substantial amount of cash ready to go for your next acquisition may appear to be the easiest way to ensure your portfolio keeps growing, but it’s not always possible.
A lack of cash doesn’t have to stall your purchasing. There are various methods that allow you to bypass the need to save up tens of thousands of dollars in cash, giving experienced investors and first-time buyers the opportunity to act now.
A guarantor loan enables an existing Australian homeowner, such as your parents, to provide a limited guarantee for your mortgage. The guarantor uses equity in their own property as security for the borrower’s loan. The primary security for the loan is still the borrower’s new property. Lenders offering these loans also put a mortgage over the guarantor’s property, which supports the guarantee.
These loans are generally used by people who have an insufficient deposit but can afford the loan repayments. Guarantor loans enable the borrower to borrow the full purchase price of your chosen property, and also often the additional loan costs and expenses that come with purchasing property.
Otto Dargan, director of Home Loan Experts, says guarantor loans are the best way to get a property if you don’t have enough cash saved for a deposit.
“You can borrow the full amount of the purchase prices as well as costs such as stamp duty. As if that wasn’t good enough already, you also pay no lender’s mortgage insurance (LMI) and you can get better rate discounts than someone who is borrowing 95 per cent,” he says.
“The catch is that your parents must provide a limited guarantee, which is secured by their property. The second catch is that only a couple of lenders will allow you to use a guarantor loan to buy an investment property.”
Mr Dargan concedes not all property investors will be able to take advantage of this method, particularly if their parents are older. However, he says there are other ways investors can use their family to speed up the property purchasing process.
“If your family doesn’t feel comfortable with that, then they may be able to gift or loan you a deposit,” he says. “The problem with this is that many lenders like to see genuine savings before approving your loan. If you didn’t save your deposit, then they may not be sure you can handle your money responsibly and it will be harder to get a loan. Not every lender requires you to have saved a deposit, and a good mortgage broker can help you to get approved.”
Ryan Crawford, founder of Crawford Property Group, says a guarantor can usually be released from the agreement once the property has built sufficient equity.
“This can be a very helpful strategy for first-time investors, but there are risks,” he says. “The guarantor will be required to seek legal and financial advice beforehand, to ensure they are aware of risks and their potential liabilities.”
If you set up an SMSF then you can borrow 80 per cent of the property value and your super can fund the rest.
Some people may consider themselves cash poor but have thousands of dollars stashed away in superannuation. If this is the case, they may be able to use a self-managed super fund (SMSF) to get into property without having to save additional cash.
Sam Saggers, CEO of Positive Real Estate, says investors are increasingly using this strategy to purchase property, but warns that it’s not the simplest way to do it. Setting up an SMSF isn’t as simple as signing a form, he says, and there are many legal, financial and strategic considerations that investors need to be aware of before jumping in.
Clayton Daniel, principal adviser at Hillross Silverstone, says investors need to make sure they have substantial cash in their superannuation before considering setting up an SMSF to get into property. Opinion is divided about just how much superannuation you should have before establishing an SMSF, but Mr Daniel says to cover the costs and administration associated with the funds, you should have a minimum of $200,000 in super before considering an SMSF.
Mr Dargan says despite the increasing popularity of this strategy, some people still overlook this option and believe they can’t get into their next property.
“Many people overlook buying a property using their super. If you set up an SMSF then you can borrow 80 per cent of the property value and your super can fund the rest. This means you don’t have to save a deposit yourself. But if you have no super, then you are out of luck,” he says.
If you already have substantial money in your superannuation and won’t be able to save extra cash, this method is worth looking into – but it’s definitely not something you can do on your own. Make sure you get the appropriate financial and legal advice before you get going.
If you’re already a homeowner or investor, you’re in luck! You could already be sitting on a substantial amount of equity that will negate the need to save a cash deposit for your next purchase.
Mr Dargan says he has seen a rise in people refinancing their loans on existing properties to buy again.
“We’ve seen some incredible growth in house prices in the last 12 months, particularly in Sydney,” he says. “A lot of our customers are refinancing their home loans to 90 per cent of the new higher value of their home and using the money as a deposit to buy their first investment property.
“It’s exciting to see people who may have only just bought a property a year ago already able to do this because the value of their existing property has gone up.”
Mr Crawford says the equity is used as a line of credit to secure your investment, but buyers should remember that you won’t usually be able to borrow the full amount of equity that has been created.
“The banks still need some security on your home, so will typically require a portion of the equity to be held back,” he explains. “You will also need to pay LMI if you borrow more than 80 per cent of the cost of the investment property. The equity the banks will let you borrow against is very much dependent on your particular circumstances.”
Mr Dargan says there are little things you can do to squeeze more equity out of your existing property and thus increase the amount you can borrow for your investment.
“These days, brokers can order upfront valuations with several lenders,” he says. “If your bank didn’t give you a very good valuation, then we can check to see if another one can.
“Of course, it doesn’t hurt to cover the basics such as making your property look good and doing your own comparable sales research to discuss with the valuer.”
Mr Crawford agrees that presentation can make a big difference to the valuation you receive for your property.
“To ensure your property achieves the highest valuation possible, you need to keep it well maintained and make some aesthetic improvements if necessary.
Agents will often provide free valuations to give you an idea of the market price and can also offer advice on how to improve a property,” he says.
“However, lenders will do their own valuations and investors should be prepared for these to come in under what they believe the market value to be. Making cosmetic changes, renovating or adding a granny flat can be very advantageous to your equity, provided you have done your homework.”
Squeezing more from your equity can also involve looking at different lenders and taking advantage of what’s on offer in the marketplace, he says.
“Shop around for a lender. Each lender has different assessment criteria and your approved amount could differ by tens of thousands of dollars between lenders,” he says.
Mr Crawford cautions that investors shouldn’t get too carried away with this though.
“Be aware that each application is recorded on your credit record and this could lead to rejection from a chosen lender if they see you have made multiple applications,” he warns.
“A good way to avoid this issue is to seek help from an experienced mortgage broker. They will know which lenders are likely to be more flexible with their borrowing capacities and can offer a variety of products from different lenders, at no cost to you.”
Mr Crawford says as investors grow their portfolios, understanding your equity and finance structures will become increasingly important. A large part of this will involve using different lenders, he says.
“As you grow your portfolio, diversify your lenders. Utilising different lenders for different properties will give you greater flexibility in terms of products, reduce risk and will provide more opportunity to further build your portfolio,” he says.
“It can be tempting to stay with one lender for simplicity, or you may be looking to co-secure the loan rather than take out a separate one. While this strategy does have its benefits, such as potential costs savings and the advantage of not having to pay LMI if your deposit is less than 20 per cent, there will ultimately be a limit as to what a single lender can offer.”
Buying with friends or family who have a deposit available can work if you trust each other to be responsible and do the right thing.
You might not have cash savings, but it’s likely that someone you know does. Some investors decide to buy with a friend or family member to circumvent the need to save extra cash and speed up their entry into the property market.
For this to work, Mr Dargan says each participating party must bring something to the table.
“Typically, one friend has a deposit and the other has a good income, or one friend is a tradie who can renovate the property and the other has the deposit and income to service the debt,” he says.
He warns that these agreements can seem appealing at first, but investors do need to tread carefully and plan for changes in circumstances.
“I would say it’s better to buy a property on your own if you can. You may find that you and your friend end up having different financial needs at different times. One of you may have a baby and then want to sell the investment, whereas the other wants to keep it. If you do invest with a friend, then it works best if you have clearly defined goals, expectations and an exit strategy,” he advises. “Otherwise, you may not be friends in a few years’ time.”
Mr Crawford agrees and says you need to be sure you’re entering into the agreement with the right person.
“Buying with friends or family who have a deposit available can work if you trust each other to be responsible and do the right thing,” he says. “A typical arrangement may take the form of your partner supplying the deposit, you taking out the finance and the profits being split 50/50.”
Government grants vary from state to state, but some investors are able to take advantage of these and avoid saving a full deposit.
For example, in New South Wales, first-time purchasers can use the First Home Owner Grant (New Homes) Scheme, which gives them $15,000 for new homes valued under $650,000. The applicant must occupy the home as their principle place of residence for a continuous period of six months, commencing within 12 months of settlement or construction of the home.
New investors who can meet this requirement can then use the property as an investment.
Mr Dargan says investors should research which grants are available because they can significantly reduce how much you’ll need to save.
“In some states there are grants for people who buy or build a new property, and they’re not all just for first home buyers – investors can benefit too,” he says.
“This is an effective way to reduce the size of your deposit because the valuer will not take the same conservative approach they take with developer cashbacks.”
If grants are on offer – why not use them?
Vendor finance is a private lending arrangement that doesn’t need to involve lending institutions. Instead, the vendor sells their property to you and you will make agreed repayments to them over a specified time.
This method of property acquisition may not require you to have a sizable deposit, but it is reliant on you being able to make the repayments.
Mr Crawford says this financing method can be an excellent choice for people who are struggling to get their foot onto the property ladder, or those who are struggling to get their next deposit together.
“Many people are unfamiliar with vendor finance, but it has in fact been used in Australia for over a century and while it is increasing in popularity, it still flies under the radar of most investors,” he says.
“It’s a popular service offered by developers who want to increase their pool of prospective buyers by offering more flexible finance options. Vendor financiers will often lend 90 per cent to 100 per cent of the purchase price, which makes properties offered under this scheme attractive low-deposit options.
“With good property selection, many investors will have generated decent equity in the property over those initial years, putting them in a much better position with the banks.”
Mr Saggers says this strategy works particularly well when vendors are keen to get rid of their property as quickly as possible. These sellers may be willing to leave 10 per cent of the property’s value for you, allowing you to borrow the other 90 per cent from a lender, he says.
Mr Dargan says vendor finance can help you bypass saving a deposit, but you need to go into it with a solid plan.
“The property is usually sold to you for a slightly higher price, but the vendor will lend you part of your deposit,” he says. “It can help you to get into the market, but you need to have a strategy to refinance the loan from the vendor into a standard bank loan at a later date.”
Using vendor finance should be considered a bridging strategy, Mr Crawford says.
“It’s generally not considered a long-term option and is typically used as a bridging strategy. It allows investors to get their foot in the door, secure a property and then look to refinance with a bank in two to three years when they have established a payment history,” he says. “It’s also usually provided at a higher interest rate to bank finance. This is less of an issue in our current super low rate environment, but remains an additional motive for refinancing.”
In some states there are grants for people who buy or build a new property and they’re not all just for first home buyers – investors can benefit too.
Property options: rent to buy
Property options are a form of vendor finance, which We Buy Houses’ Rick Otton says are exploding in popularity.
Large-scale property developers frequently use property options to obtain the right to buy a property before a set future date for an agreed price. During the time between the agreement and the cut-off date, they may push a development application through and then purchase the property.
Smaller-scale investors can use property options slightly differently and enter into a ‘rent to buy’ agreement.
Potential purchasers will generally pay an agreed amount over and above market rent. These additional funds go towards forming their deposit for the property.
During the renting period, the property remains in the name of the vendor, but the renter is working towards owning the property.
The vendor and potential purchaser will reach an agreement and set an agreed future purchase price and an expiry date for the deal. These arrangements give the purchaser the ‘option’ to purchase the property at any time before the cut-off.
If they decide to exit the arrangement and not proceed with the sale, the vendor will keep the additional funds and the rent.
Mr Otton says people use this option when property price growth is outpacing their ability to save.
“One of the things we’re hearing more and more these days is ‘By the time I’ve saved up my deposit, house prices keep going up so we can never catch up’,” he says.
This way, investors can put down as little as two per cent of the property’s value and build up their ownership stake.
Self-employed investors, as well as those people who have recently relocated to Australia, are increasingly taking advantage of these arrangements, Mr Otton says.
Investors who like to add value to properties through renovations could also benefit from rent to buy property options, he says. This enables them to cut out the intermediary – in this case, the bank – and add value without involving upfront loans and large deposits. Their cash can instead be used to finance the renovation.
Mr Otton says these renovators live in the house for a few months, renovate to add value and then buy the property from the vendor at the agreed price before on-selling it at its new market value.
Mr Otton says novice investors can see this method of property acquisition as overly complicated, but insists that if you have a good solicitor, the process won’t be overwhelming.
In addition, he says the agreement is an option, not an obligation, so once the rent to buy agreement expires, the renter doesn’t actually have to go through with the purchase.
Rent to buy agreements shouldn’t extend beyond a few years, Mr Otton cautions. Purchasers should work towards building up their deposit in the property as quickly as possible and then become the owner.
Anthony Cordato, solicitor with Cordato Parners, says with the new credit reporting regime starting on 12 March, he anticipates more people will use these arrangements to improve their borrowing capacity.
“Until now, credit records have only contained the negative things – if you’ve defaulted for 60 days or more, or you’ve had a whole lot of loan applications and things like that,” he says. “So to date, if you’ve wanted a loan, that’s all the lender could see and all they were interested in. But they will now be interested in your credit history, your payment history, for the past two years.
“With rent to buy, you’ll build up a great payment history, which can then be taken into account by the lenders when you move to purchase the property completely.”
Steps to getting the highest valuation possible
If you want to extract existing equity from your home, you will need to try to get a favourable valuation.
- First impressions count. Make sure your property is well maintained and make small aesthetic improvements if necessary.
- Curb appeal is important. A freshly mowed lawn, free of weeds and neat hedges will improve the overall appearance of your property.
- Keep a list of all the updates you’ve made to the property. Make sure you include even small items because the valuer might not notice them.
- Keep an eye on nearby sales and have the information ready for the valuer so you can compare prices and information.
- Ensure the valuer is comfortable. An excessively warm property, or a pet that constantly gets in the way might not impact on your property’s value, but it will affect the valuer’s mood.
Rent to buy was introduced as a category in the 1996 Census and accounted for 0.5 per cent of occupied private dwellings that year. In previous years, this tenure category was not separately catered for by the Australian Bureau of Statistics