Calculating Your Budget

Below I have noted important areas for you to consider during the “ mathematical juggling” that always happens whilst calculating your budget, and working out what you will have available for the purchase of your rental property :

Purchase Price .. Down Payment .. Loan Interest Rate .. Repaying the Mortgage Loan .. Other Regular Costs .. Final Thoughts

(A) Purchase Price …… is this set at current market values?

Check similar properties in the locality, check if it has been empty for a long time, and if it has been on the market for a long time … the longer it has been empty the more keen the seller will be to make a sale …. And as a consequence there is a better chance of a lower offer being accepted for a “quick” sale.

(B) Down Payment ( Deposit payment )

Depending on what capital you have available will determine how much cash you can put down on your rental property.
It is assumed that the difference between the deposit and purchase price is going to be met by a mortgage.

This next bit is important to understand:

The lower your deposit, the higher the “ risk” that the lender is taking on board with your purchase.
As a consequence the higher the “risk” from the lender’s point of view means the higher their interest rate will be along with higher fees and, more than likely, some kind of long term redemption penalties.

Wherever possible put down a good Deposit to keep the Loan to Value ( LTV ) ratio below 70%. This will give you access to better rates and conditions in the mortgage package.

(C) Loan Interest Rate.

As already mentioned, the higher the LTV ratio, the higher the Lender’s risk will be.
This “exposure” to risk means they are going to charge you for the risk they are taking, and therefore the higher the Interest rate will be.

(D) Repaying the Mortgage Loan

There are two ways to approach this area

(1) Take out an interest only loan with the intention of either paying the loan back from other capital sources, or selling the property in the future to repay the loan.

At this point you are hoping that the sale price handsomely exceeds your purchase price, and therefore provides you with a good profit (Capital Gain).

Historically, property prices do increase over time. This includes taking into account violent downturns in the property market like at present.

Prices do recover, and hopefully, you can hold onto your property until you find yourself in a period where property prices are on the increase, allowing you to achieve a good return on your initial capital investment.

It is not rocket science here, but I feel it is important to point out that were prices to fall during your ownership of your rental property, you may find that when you sell your rental property, you cannot repay all the outstanding mortgage from the sale proceeds and a “shortfall” occurs.

You will therefore have to find the “shortfall” payment from other capital sources.

(2) The second way to pay the interest is to set up a Repayment mortgage Loan which means that each month your payment is split into two payments, with the first payment being used to pay Interest on the outstanding loan, and with the second payment being used as a part capital payment.

The major difference with the second method of repaying your mortgage is that the second method guarantees to repay the mortgage loan on your rental property by the end of the mortgage term.

The shorter the term of the loan, the higher your monthly payments will be.

Conversely, the longer the term, the less your mortgage payments will be.

It is up to you to decide what is affordable each month, and to ensure that the lender is prepared to accept the fact that you want a Repayment mortgage over a set number of years.

(E) Other regular costs

As part of your budgeting exercise, you have to consider other regular costs which you are going to have to allow for:

Property Insurance, Public liability Insurance ( normally part of the property insurance), costs for maintaining your rental property,

(F) Final Thoughts

When you are working out all your income figures, bear in mind the fact that your rental property may not be full for 12 months per year, and therefore you have to allow for the fact that it may be empty for a number of months, whilst you seek a new tenant.
This factor makes the level of rent you will be asking for the rental property an important factor.

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You have now had access to the first two articles in this mini series of 3 articles :

Your Cashflow (article 1)

Calculating your Budget (article 2) .

The third and final article will look at  how to Find your Rental Property

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