Can I buy an investment property with a 20% deposit?

Introduction

When it comes to purchasing an investment property, one of the first questions many buyers ask is whether they can secure a loan with a 20% deposit. While a 20% deposit has long been the standard for property purchases, the reality is that there are multiple options available, even if you don't have the full 20% upfront.

In this blog post, we will take a closer look at the role of the 20% deposit, the benefits of putting down a larger deposit, and what alternatives exist if you’re looking to buy with a smaller initial investment.

What is a 20% deposit for an investment property loan?

A 20% deposit refers to the amount of money you pay upfront when purchasing an investment property. This deposit represents 20% of the property's total value, and the remaining 80% is typically financed through a mortgage from a lender. For example, if you are purchasing a $500,000 investment property, your deposit would be $100,000, and the lender would finance the remaining $400,000.

How to calculate the 20% deposit for your investment property?

Calculating the 20% deposit is simple when securing a loan for investment property. Multiply the total price of the property by 0.20. For instance, if the property costs $500,000, the calculation would be:

$500,000 x 0.20 = $100,000

This means you will need to save $100,000 as your deposit. The lender will cover the remaining $400,000 with a mortgage.

It’s important to factor in any additional costs that may arise, such as stamp duty, legal fees, and inspection costs. These can add up quickly, so make sure you budget accordingly.

Why is a 20% deposit the standard for investment property loans?

A 20% deposit is widely considered the ideal option for property investors for several reasons. It strikes the right balance between accessibility and risk management. Here are a few reasons why it is considered standard:

1. Loan-to-value ratio (LVR) and risk reduction

When you provide a 20% deposit, the loan-to-value ratio (LVR) is reduced to 80%. The LVR is the ratio of the loan amount to the property’s value. For example, if you are buying a $500,000 property and provide a 20% deposit ($100,000), the remaining loan is $400,000. This results in an 80% LVR. A lower LVR is less risky for the lender. If the property value declines, the lender still has a buffer to recover their funds.

2. Financial stability and credibility

A 20% deposit shows that you are financially stable. It proves to lenders that you can manage a significant portion of the property’s cost upfront. This builds trust and makes it easier for you to secure a loan. Lenders prefer borrowers who are financially disciplined.

3. Avoiding lender’s mortgage insurance (LMI)

When you put down a 20% deposit, you can avoid paying Lender’s Mortgage Insurance (LMI). LMI is usually required if your deposit is less than 20%. By saving on LMI, you reduce the overall cost of your loan, which can add up to thousands of dollars.

4. Better loan terms

Lenders typically offer better loan terms to borrowers who provide a 20% deposit. With a lower LVR, the loan is seen as less risky. As a result, you may be able to secure a lower interest rate. Over time, this could save you a significant amount of money.

5. Increased borrowing power

A 20% deposit improves your borrowing power. Since the lender’s risk is lower, they may be willing to offer a larger loan. This can help you invest in higher-value properties that better align with your investment goals.

How does a 20% deposit impact my borrowing capacity?

The amount of deposit you put down directly affects your borrowing capacity. A larger deposit reduces your LVR (Loan-to-Value Ratio), which can make it easier to secure a loan and potentially borrow more. A smaller deposit increases the LVR, which can limit how much you can borrow.

In addition to the deposit, lenders will also consider other factors, such as your income, employment status, debts, and the property’s location. By demonstrating financial stability and having a substantial deposit, you increase your chances of being approved for a loan with favourable terms.

If you are considering securing a loan with a smaller deposit, it’s important to explore different types of investment property loans to understand the best financing solutions available to you.

Is it possible to buy an investment property with less than a 20% deposit?

Yes, it is still possible to buy with a smaller deposit. With ZedPlus, you can purchase an investment property with as little as a 10% deposit. However, this will require paying Lender's Mortgage Insurance (LMI).

LMI can add significant costs, but it enables investors with smaller deposits to access financing. The cost of LMI depends on factors such as the size of your deposit, the property value, and the type of loan. If your deposit is less than 20%, it's important to consider whether the costs of LMI are worth the advantage of purchasing sooner, rather than waiting to save for a larger deposit.

If you are looking to avoid paying LMI charges, it's helpful to understand different strategies that could reduce this cost. Check out our blog on 6 tips to avoid paying LMI charges on your home loan for more information.

How can I improve my chances of getting approved with a smaller deposit?

If you are unable to provide the full 20% deposit for your investment property, there are several strategies and alternatives you can explore to increase your chances of approval. These methods aim to reduce the lender's perceived risk and demonstrate your ability to manage the loan, even with a smaller upfront payment.

Improve your credit score

One of the most significant factors affecting your loan approval is your credit score. Lenders use your credit score to assess how responsibly you have managed debt in the past. A higher score signals to lenders that you’re more likely to repay your loan on time.

To improve your credit score, pay off outstanding debts, ensure bills are paid on time, and check for errors on your credit report. A higher credit score can make you appear as a low-risk borrower, potentially compensating for a smaller deposit.

Explore a range of proven and innovative ways to improve your credit score, which can unlock better financing options and loan approval rates.

Demonstrate financial stability

Lenders want to see that you have a stable and sufficient income to cover your mortgage repayments. Demonstrating a consistent work history and a reliable income stream is key. If you’re employed, a stable job with a consistent income stream for at least a couple of years can make a significant difference.

For self-employed borrowers, having solid financial statements, tax returns, and profit-and-loss statements that show a stable income over the past 2–3 years is important. The more stable your financial situation, the more likely you are to convince lenders to approve your loan, even with a smaller deposit.

Reduce your debt-to-income ratio (DTI)

Your Debt-to-Income ratio (DTI) is a key indicator for lenders, as it shows how much of your income is already committed to existing debts. A high DTI suggests that you may struggle to meet additional financial commitments, making it harder to secure a loan.

To reduce your DTI, pay off existing loans, especially high-interest loans and credit cards. Consider consolidating your debts to lower monthly obligations. A lower DTI gives lenders confidence that you can manage a new loan, making it easier to approve your application with a smaller deposit.

Leverage equity from other properties

If you already own property, you may be able to use the equity in your existing home to fund the deposit for your next investment property. This strategy allows you to leverage your current assets to access additional funds, helping you grow your investment portfolio without the need for a large upfront deposit. However, keep in mind that it also increases the amount you owe on your existing property, so it’s important to carefully assess the risks.

Explore government assistance programs

There are several government initiatives available to property investors in Australia. These programs are designed to reduce your investment costs and increase your profitability.

One key program is negative gearing for property investors. It allows you to offset property expenses like loan interest and maintenance costs against your taxable income, reducing your overall tax liability.

In addition to negative gearing, you can access tax incentives, such as deductions for depreciation and capital works. Some states also offer grants for property development and renovation. These programs help you manage costs and maximize your returns.

Joint venture investments

Another option is to team up with other investors in a joint venture. By pooling resources, you can share the deposit, risks, and rewards of property investment. This approach allows you to access larger or more lucrative properties than you might be able to afford on your own. It also helps reduce the financial burden of a large upfront deposit, while still allowing you to participate in profitable investment opportunities.

Family guarantee loans

If you have family members who are willing to help, a family guarantee loan might be an option. With this arrangement, a family member, typically a parent, can act as a guarantor for the loan. This allows you to borrow a larger amount, often up to 100% of the property’s value, without requiring a large deposit.

The guarantor offers their property as security, and if you default, the lender can claim the guarantor’s property. While this option reduces your need for a large deposit, it requires trust and a solid financial relationship with your guarantor.

Negotiate loan terms

Shopping around and negotiating with lenders can help you find a better deal, even with a smaller deposit. Lenders may offer more flexible terms based on your financial profile. Use your credit score, stable income, and low DTI ratio to negotiate better terms. At ZedPlus, we help you find lenders who are more likely to approve a loan with a smaller deposit or offer better loan conditions.

Save over time

If you are not in a position to meet the 20% deposit requirement right away, consider saving over time. A few extra months or years of saving can provide the financial buffer you need for a larger deposit, improving your borrowing capacity and helping you secure better loan terms. Set up a dedicated savings account for your deposit and make regular contributions to reach your goal.