Buying a Second House and Renting the First in Australia

February 7, 2023
Buying a Second House and Renting the First in Australia

Buying a second house and renting the first in Australia is a big financial commitment to make.

Not only do you have to account for the property purchase, but you also have to factor in the costs of other external aspects. Before proceeding to the next step, you might need to consider weighing out the pros and cons of that.

If you are contemplating your next step, this guide might help you make a more informed decision.

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Why are you buying a second property?

Buying a Second House and Renting the First in Australia

Buying a second house and renting the first in Australia can be a good strategy to gain financial freedom.

One of the few questions you may need to ask yourself before taking the plunge would be to identify the main reasons why you want to purchase a second property.

Most homeowners in Australia turn their first home into an investment property by renting it out to earn some passive income and grow their wealth.

When buying a second property, establishing your intentions might be the most feasible option to take in your thought process.

Will you be renting out your first property short-term or long-term? Are you simply waiting for the value to appreciate more over time before purchasing?

It’s always a great achievement when you buy your first property, but when you feel like you need to change your environment or have grown out of your home, making that second property purchase might be a viable option.

The intentions you identify also affect the property type you plan to purchase.

Can I get a home loan?

Buying a Second House and Renting the First in Australia

Before you start buying a second house and renting the first in Australia, you will need to consider your financial situation. Checking your finances will give you an idea if you need to get a home loan to finance your purchase.

If you do not have enough to sustain the entire process and its costs, now might not be the right time for you to be looking for a second property.

You can consider making calculations using a home loan calculator to see how much money you need to loan out. Alternatively, getting professional advice on making loans and your financial capability might help greatly.

How much deposit is required?

Buying a Second House and Renting the First in Australia

The deposit required when buying your second property is the same as that required for your first home.

If you have owned your first property for a long time now, the good news is that you do not have to scramble to come up with the deposit to buy your second house. You may be able to leverage your equity in your home as a deposit.

How does equity work and what is your borrowing power?

Buying a Second House and Renting the First in Australia

As established previously, if you rent out your first property and purchase a second home, you may want to consider getting a new home loan.

In most cases, when you have enough equity from your first home, it can be used as additional security for the loan made on your second property.

The amount of money you can borrow is dependent on these few factors:

  • The equity your first home possesses
  • Your ability to service your current home loan on your existing property, plus the new loan amount
  • The total amount borrowed across both loans compared to your properties’ valuations

What is home equity?

Home equity is the difference between the balance on your home loan and the market value of your property.

A few ways you could have built up equity would be in these situations:

  1. If your first home has appreciated in value since the time that you purchased it
  2. If you have paid all or some of the home loan on your first property

You can buy your second property with no deposit if you have enough equity built up from your first property. The more useable equity you have in your first home, the more you may be able to borrow for a second home.

What type of mortgage should you get?

When buying a second house and renting the first in Australia, you will need to apply for a home loan. There are various kinds of home loans you can apply for that suits different individuals.

There are loans with fixed-interest rates and loans with variable interest rates, principal-and-interest or interest-only repayments as well.

You will also need to think about using an offset to reduce your interest repayments or whether you want to get a package with your existing home loan (considering if you have not paid it off.)

To determine which type of loan suits you, you may want to consult a lending specialist.

You may have a higher borrowing cost with an investment property

One more thing to consider is the structure of your loans on both properties.

Interest rates on home loans will definitely be higher on your investment property as compared to when you live in your property on your own.

With this fact to account for, you have to speak with your lender to discuss how you want to structure your home loans and what is the best way to use the equity from your first home to finance your second property.

What are the tax considerations involved?

Buying a Second House and Renting the First in Australia

Buying a second house and renting the first in Australia is not an easy thing to do. There are a few tax items you need to consider when it comes down to converting your first home into an investment property.

Tax deductions

As your investment property (your first home) is no longer your principal place of residence (PPOR), you might be able to claim deductions on some of the interest paid as part of your mortgage repayments as well as costs associated with maintaining the property.

There are other repayments you can claim from your rental property, such as depreciation, calculated at a rate of 2.5% per year in the 40 years following construction, and could apply to extensions and renovations.

Capital gains tax and tax-free status

Your PPOR is usually exempt from Capital Gains Tax but your investment property might not be exempt from it. This is often only applicable when you sell your house.

If plan to sell your first property down the track, you should research on capital growth trends for similar properties like yours in the area.

As properties do appreciate in value over time, you are most likely able to make capital gains from it when you sell your first property.

You may continue treating your first home as your main residence for capital gains purposes when you stop living in it and rent it out for up to six years. However, you have to consult your tax adviser to determine the capital gains tax implications from the sale of your first property.

Rental returns

Your investment property has the ability to generate monthly rental income for you.

When your monthly rental income is ‘positively geared‘, this means that the monthly rental income is greater than the costs of maintaining the property – including any mortgage repayment costs.

Essentially this means that you profit from earning the monthly rental income.

If you are looking at purchasing a positively geared property that can yield rental returns, you should establish if the rent you collect every month is enough to cover your costs.

On the other hand, if your property is ‘negatively geared‘, in Australia, you can potentially claim the loss against your regular income, thereby reducing your taxable income and tax payable.

In the event that the rent on your property does not cover the costs, you may need to consider if the property is able to gain equity as it appreciates in value over time. If the property is unlikely to do either of these things, it may not be a sound investment.

What are the property investment costs involved?

Buying a Second House and Renting the First in Australia

Buying a second house and renting the first in Australia does come with additional costs so you need to ensure that you have a positive cash flow or a cash buffer if your rental income is insufficient.

These costs include the following:

Rent shortfall

If your home loan repayments and ongoing property costs are greater than the rental income you’re getting, then you’ll need to cover the shortfall.

Loss of tenancy

You need to have saved enough capital to make mortgage repayments in the event that your rental becomes untenanted.

Maintenance costs

Every building, whether old or new, will require maintenance at some point in time.

As a landlord, it is your responsibility to respond straight away if your tenant requests urgent repairs. The landlord is responsible for organising repairs but the tenant can be asked to pay for any damage they cause.

In these circumstances, you need to ensure you have sufficient funds for emergency repairs, regular maintenance and renovations.

Utility bills

As the owner, you’re still responsible for paying certain utility bills, such as water, council fees, and if you own an apartment, even strata fees.

It is however up to the tenant to pay for the services they consume.

Landlord insurance

As a landlord, you might need to pay for landlord insurance.

Your rental property is a valuable asset, so it will be wise to get it insured. Taking out cover after you have exchanged contracts can mean you’re protected if the property is damaged before settlement.

There may be additional risks involved when you rent your property out to tenants. Landlord insurance can provide extra protection that goes beyond regular building or contents cover.

Landlord insurance typically includes include building insurance, landlord contents insurance and property owner liability insurance.

Real estate fees

If you contacted your local real estate agent to manage your property on your behalf, you may need to pay property management fees.

Property managers charge a range of fees. A one-off fee called a letting commission can be charged when the agent signs a new tenant.

Home loan rate changes

If you have a variable rate home loan you will need to make sure you can afford any rate increase.

Changes in circumstances

Make sure you consider whether you can cover the loan repayments if your personal circumstances change.

How do you determine if your first property has a rental appeal?

Buying a Second House and Renting the First in Australia

You probably loved your first property when you decided to purchase it. It’s your first home after all. But to determine if your home has rental appeal, would others love it as well?

You can consider discussing with your local real estate agent to discuss ways to maximise your home’s rental appeal.

Here are some questions you can ask your real estate agent:

  • Is the location of your house an area where people want to rent?
  • Is it going to be easy finding and maintaining good tenants?
  • Is my home close to public transport, the shops and other amenities?
  • Does it have any potential features or issues that may put renters off?
  • Does it require any repairs or renovations to bring it up to a rentable standard?

If your property is able to meet these standards, it definitely has rental appeal.

So essentially…

Buying a Second House and Renting the First in Australia

Here are a few last things you must remember before making your decision:

  1. Make sure you research your property market. Find out how much you should rent your property for, and if the sale of it can cover your second home loan.
  2. Don’t rush into things! Take your time to carefully build up your home’s rental appeal. Seek professional advice from your local real estate agent to find out about the latest property trends.
  3. Get financial and tax advice. You need to find someone who can tell you the best thing to do in your situation.
  4. You need to take note of all costs that go into the investment property and learn how to manage it.
  5. Find out more about your first home equity and also what mortgage options are suitable for you to rent our hour first home and buy a second property.

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