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Guide to buying a second home in NZ

If you’ve owned a property for a few years you could have a good amount of equity tied up in it, particularly after the increase in property values over recent times. It may be possible to use this equity for the deposit on a second home and still keep your current one. If you buy carefully, there’s a good chance of continuing to build equity in two homes, not just one.

This guide explains how to buy a second property with no money down in New Zealand, as well as some ownership and finance models to consider.

Using equity to buy a second property in NZ

Equity is the difference between what your property is worth and the size of your mortgage. The equity you have in your home will increase as its value goes up and as you repay your mortgage.
Home equity calculations

Here’s an example to explain equity: If you bought your home some years ago for $500,000 and paid a 20% deposit of $100,000, you started with a mortgage of $400,000 and $100,000 in equity.

If your home is now valued at $1m and your mortgage has been repaid down to $300,000, the equity in your home will have increased to $700,000.

How much equity to buy a second home can you use?

The amount a bank will lend you, using your current home as security, will depend on two things – the value of your home and the regular mortgage repayments they believe you can afford.

For a house you live in, banks will normally let you borrow up to 80% of its value, not the full amount. This limit’s known as the loan-to-value ratio (LVR) and the Reserve Bank requires the main banks to apply it in most cases. It’s designed to ensure that if you can no longer meet your regular mortgage repayments, the bank can sell your home and recover the money you owe, even if property values have fallen.

This means the amount you can borrow for a deposit on a second property will be up to 80% of your current home’s value, less what you currently owe on your mortgage.

Useable home equity calculation

Continuing the above example, if your home is now valued at $1m, 80% of that is $800,000. As the mortgage is now only $300,000, you may be able to borrow up to $500,000 more. This assumes you can afford the regular repayments on what would become a mortgage of up to $800,000. Remember that you may have rental income to help with the repayments.

What is the minimum deposit for a second property?

When you own more than one property, the ones you don’t live in are known as investment properties. If you live in two of the properties during the year, the one you live in the least is judged to be an investment property.

To help prevent people investing beyond their limits, and to make it easier for people who are only buying a home to live in, the Reserve Bank and the main New Zealand banks require a higher deposit if you’re buying a property as an investment.

The deposit required for investment properties is now 40% of the property’s value. That means the bank will only lend you up to 60% of its value, so the maximum loan-to-value ratio (LVR) on a second home is only 60%.

How to choose a good second house

The best type of investment property for you will be determined by your particular circumstances. It typically depends on how much money you have to invest, your ability to contribute to the regular mortgage repayments and what sort of property improvement projects you’re prepared to take on, if any. It’s also about finding the right balance for your immediate and future needs. To start narrowing down your choices, here are three things to consider as part of that balance.
Rental income return

The annual income from an investment property is known as its yield. It’s usually measured as a percentage of the property’s value. If it simply refers to the rental income, it’s called the ‘gross yield’. If it’s the annual rent, less expenses (not including mortgage interest), it’s known as the ‘net yield’.

If you’re borrowing most of the property’s value, you may need a high yield in order to afford the regular mortgage repayments. You may also prefer a high yield if you only have a small mortgage but rely on the rent for personal income, for example if you’re retired.

Properties that typically provide a high yield include apartments, home units and homes in less expensive areas. They cost less to buy but attract a reasonable rent for the outlay. The downside is their value tends to increase more slowly.

Steadily increasing value

When the value of a property increases, it’s known as capital gain. If your goal is to build wealth, rather than earn an income, your focus might be more on properties that would be expected to show stronger-than-average price increases or capital gains. However, properties that give the strongest capital gains tend to provide the lowest yield or percentage rental income for their value. That means you may need a substantial deposit or a strong enough personal income to subsidise the regular mortgage repayments.

Capital gain is usually driven by demand. So areas where there is strong or growing demand will typically have higher than average increases in property values. Demand can be driven by a wide range of desirable factors, such as:

  • Well-regarded schools
  • Growing employment opportunities
  • Close proximity to tertiary education
  • Low crime statistics
  • Nearby parks, beaches and other lifestyle amenities
  • Easy access to frequent public transport

Capital gain is usually expressed as a percentage of a property’s value. That means a more expensive home will typically provide you with a greater increase in wealth over time. However it’s possible the rental income will be less than the mortgage repayments, (particularly principal and interest) even with a 60% mortgage.

The potential for property improvements

Another way to increase your wealth through a second property is to buy one with the potential to add immediate value through an improvement project. This doesn’t appeal to everyone and you need to know what you’re doing. It’s easy to end up spending more on the improvements than the resulting increase in value, if you’re not careful.

Properties with potential for value-adding improvements can be:

  • Dated on the inside with an unappealing kitchen, bathroom and laundry. But be careful. These rooms are usually the most expensive areas to renovate because they require plumbing, electrical, carpentry, tiling, painting, tapware, appliances and so on.
  • Run down and shabby, but structurally sound.
  • Lacking in road appeal with overgrown and un-landscaped gardens.
  • Homes on a large section that offer the potential to add a bedroom or extend living areas, subdivide or demolish completely and build two new residences.

How banks calculate the second home mortgage you can afford

In addition to the loan-to-value ratio mentioned above, the amount a bank will lend you to buy a second property is limited by the regular mortgage repayments they think you can afford. Each bank calculates this slightly differently, but they are quite similar.

Essentially, they subtract your living expenses from your income to calculate how much you would have available for regular mortgage repayments. A mortgage repayments calculator then reveals the mortgage these repayments would service. It’s important to realise the banks have their own rules for these calculations and they’re likely to be more conservative than you might expect.

Here’s an example to give you some idea of what’s involved.

Income

This can include your income from salary or wages, as well as the rent from your second property. However, the banks will only consider 75% of the rental income. This allows for things like vacant possession between tenants. If you’re a sole trader, contractor or own your own business, you’ll need to provide business financials and expect a fairly conservative calculation of your income. This is particularly true if you’ve only been operating the business for a short time.

Expenses
Lenders tend to use standard amounts for this based on your circumstances, such as how many adults and dependent children there are. So, if you’ve been particularly frugal on discretionary expenses, like groceries and treats, the amount they use in the calculation will probably be higher than you’d expect. You’ll also have fixed expenses, such as insurances, rates and utilities.
Existing loans and credit

If you have an existing mortgage or other loans, these will be subtracted from the total amount they calculate you can afford to borrow, and so reduce the new mortgage you can afford. The limit on each of your credit cards is also included, even if you repay them in full each month.

Calculating the mortgage you can afford

The bank will use their calculation of your uncommitted monthly income (UMI) to work out the regular mortgage repayments you could afford, and therefore how much you might be able to borrow. Here again they will be quite conservative. Even though interest rates are low at the moment, they may use a higher rate to allow for potential interest rate increases in the future. It might be around 6% in their calculation.

Example calculation

For a $1m mortgage at 6% interest rate over a 30-year term, the monthly principal plus interest payments would be $6,000 in round figures.

Buying a house with equity from another

When using home equity to buy a second home, there are several options to consider, depending on your circumstances. It pays to get advice from an independent adviser before deciding which one is best for you.
Option 1: Use your current home as security

One approach is to ask your current bank for pre-approval on a mortgage to buy a second property using both homes as security for both mortgages. However, the cross-security means you have a higher risk of both properties being sold by the bank if you can’t afford the regular mortgage repayments on either one.

Option 2: Increase your first home mortgage to create a deposit

If you have built enough equity in your home and your income means you can afford the higher regular mortgage repayments, you could borrow more (up to 80% in total of your home’s value). You could use this money for any purpose – a trip, a motorhome or in this case the 40% deposit required on a second home. This option lets you borrow the remaining 60% from a different bank to your current one, which might mean you negotiate a better deal as banks are always keen to attract new customers.

Option 3: Re-mortgage to buy a second home outright

If you have substantial equity in your current home and the income to support a much larger mortgage, there’s a third option. For this you simply increase your current mortgage, up to 80% of your home’s value and use the money borrowed to pay for 100% of a second property.

How do I rent out my house and buy another?

Many people become property investors this way, especially later in life. The family home is now too large or a better lifestyle beckons from outside the city. Buying a smaller or cheaper property, then renting out the family home provides the reassurance of being able to move back if things don’t work out. And, of course, the rental yield can repay the mortgage. When the mortgage for the new home has been totally repaid, rental yield becomes income. But there are important things to consider, some of which are mentioned below.
Loan-to-value ratios
If you plan to buy a second property, rent your current home and keep both properties in your name, the bank may only lend you up to 60% of your current home’s value because the extra home will be an investment property.
Interest deductibility
There may also be tax implications. For example, if you keep both homes in your name, all new debt will be private debt and the interest is not a deductible business expense for tax purposes. This is about to become less of an issue, as interest on residential investment properties will soon no longer be a deductible business expense.
Capital gains tax
You could sell your current home to another entity you control, typically a new look-through company (LTC). However, this may reset the bright-line test on your current home, making you liable for tax on the increased value if you sell within 10 years. This may well happen anyway, because the home would no longer be your main residence.
Will it make a good rental?

Another thing to carefully consider is whether your first home is a good rental property. Is it low-maintenance? Is the style and location of the property sought-after by renters? Is it likely to provide optimal rental yield and/or capital gains? If not, you might be better off selling it and investing in one that does.

Every situation is different and these are only potential possibilities. However, they do illustrate the importance of getting trusted professional advice as early as possible and before you sign up to anything.

How to build more equity in your home

If you don’t yet have enough equity to finance the type of second home you’re looking for, there are three main options to consider:

  • Renovate your home in ways that add more value than they cost to complete
  • Sell your current home and buy another that’s likely to provide more capital gain, probably through greater renovation potential (however you need to factor in real estate agent fees and other costs, and be confident you can find a property that will deliver the gains you need)
  • Look for ways to repay your mortgage faster, see our guide: How to pay off your mortgage faster
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