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Last Updated: 28th September, 2022

Granny flats have been touted as the “Holy Grail” of property investing as they have the potential to dramatically boost your rental income and property value.

But can you actually get a home loan to build a granny flat? More importantly, how can you qualify for it?

Can I get a granny flat loan?

The short answer is yes.

We know some lenders that may lend:

  • Up to 90% of the value of your property if you don’t have enough equity.
  • Up to 100% of the granny flat value if you have enough equity or you can use a guarantor.
  • Up to $1,000,000 of equity with full evidence of the loan purpose.

Two ways to get the money you need to build a granny flat

Call us on 1300 889 743 or complete our free assessment form to discover if you qualify for granny flat loan.

How can I qualify for a granny flat loan?

Generally speaking, it’s relatively easy to get a home loan to build a granny flat if you have enough equity in your existing property and you have sufficient income to support the new loan.

However, there are some limitations that you need to be aware of.

The loan amount

If you’re accessing less than $50,000, the banks will generally ask you to declare the purpose of the cash out but, luckily, you may not need to show evidence.

If you’re taking out more than $50,000, most lenders may ask you to provide evidence of purpose of the loan. This is particularly the case if you’re a low doc borrower.

LVR

If you’re borrowing less than 80% LVR, lenders are generally more flexible and may not need to see evidence of the purpose.

However, if you borrow more than 80% LVR, it gets a lot tighter. The banks want to know what you’re going to do with the money. In other words, they want to control the funds.

To qualify, you also need to show:

  • A solid credit history.
  • An above average credit score.
  • Stable employment.
  • Sufficient income.

Banks have different lending criteria so it’s important that you’re aware of what they’re looking for before you apply for a home loan.

The good news is, we know some lenders that only need you to declare the purpose of the loan. You don’t need to show evidence!

Please call us on 1300 889 743 or enquire online and we will work out which lender can assist you with your granny flat investment.

So how can I access the equity in my property?

When it comes to accessing your equity, you can do it in a couple of ways: use a line of credit or cash out.

For this option to work, you’d need to have built up sufficient equity in your residential property, whether it’s your own home or an investment property.

If you’re wondering what equity is, it’s the difference between the current value of your property and the mortgage on it.

Bear in mind that banks generally only lend 80% against your available equity.

For example, your property is currently valued at $600,000 and you have $400,000 mortgage on it. In this case, you can access $600,000 x 80% – $400,000= $80,000.

Line of credit vs cash out

The advantage of taking a line of credit over a cash out is that it’s simpler to track the expenses incurred against your granny flat because it’s a separate and stand alone mortgage.

However, taking a line of credit involves submitting a new application and documents to your lender. This takes a lot of time as the lender assesses your application.

On the other hand, a cash out simply means topping up your existing mortgage.

Because you’re already an existing customer, you don’t need to provide as many documents as you would when applying for a line of credit.

With cash outs, the banks are also less likely to control the funds as long as you don’t go above 80% LVR.

You don’t even need to declare a specific purpose for the cash out if your home loan stays below the Lenders Mortgage Insurance (LMI) threshold.

You simply declare it as an equity release for future investment. This is probably the best case scenario and the easiest way to do it.

Taking out a construction loan

If you don’t have enough equity in your property to borrow against, your other option is to take out a construction loan.

This is more complicated compared to taking a cash out option.

You can:

  • Borrow up to 95% of the value of the completed granny flat or up to 100% if you have enough equity in an existing residential property that you own.
  • Loan term: Up to 30 years.
  • Interest only: During the construction period.

Bear in mind that the bank will take into account the value upon completion which is relatively conservative.

The lenders also need you to show them proof of rental demand in the area so make sure you get a rental estimate from your local agent.

Note that not all lenders assess your rental income in the same way. While some banks may accept 80% of the rental estimate, some lenders may only take 75% of the rental income when assessing your borrowing capacity.

How much does it cost to build a granny flat?

To build a quality granny flat, you’re looking at anywhere between $80,000 and $150,000.

The cost depends on:

  • The size of the granny flat.
  • The fixtures and fittings used.
  • The nature of the block of land. If you have a sloping block, it would cost you more to build compared to building on a level block.

You’re also reliant on existing services such as power and sewer system. Some of these can be easier to connect than others. If it’s harder to connect to these services, the costs would be higher.

How can you make money from granny flats?

Granny flats can significantly boost your cash flow if you do it right.

Say you have a house in Western Sydney, and you decide to build a $120,000 granny flat in the backyard. Once completed, you can then rent it out for $300 a week.

Let’s break it down.

Gross yield: $300 x 52 weeks /$120,000 x 100= 13% before tax and costs

Assuming 5% interest rate:

Mortgage repayments (interest only)= 5% x $100,000/52 weeks= $115 per week

Net cash flow before tax: $300 – $115=$185 per week

As you can see, you can potentially earn an extra $185 extra income per week before tax or a whopping $9,620 per year.

Can a granny flat really boost the value of your home?

Typically a granny flat will increase the value of the property by more than the cost of construction.

This is particularly true in high-density areas or regions such as South West Sydney where there is high demand for properties that can allow an extended family to live in one place.

However, just like building a home, a lot depends on the quality of the construction as well as the supply and demand of granny flats in the area.

If you’re thinking of building a granny flat, make sure you build a good quality structure in an area where there’s a shortage of granny flats.

If there are a lot of granny flats being built in area, this can potentially diminish the value of your property going forward.

The traps of granny flats

While granny flats have the potential to significantly boost your cash flow and the value of your property, there are risks to take into account.

Granny flats may affect the marketability of your property

Granny flat is a dual occupancy property. As such, this would reduce the marketability of your property as a whole.

A house with a granny flat only appeals to a select segment of the market, which limits your potential buyers in the future.

Poor quality of construction

Unfortunately, there are a lot of poorly-built granny flats around. This is especially the case if an investor is trying to cut building costs in order to boost their yield.

Doing this would result in an ugly structure that nobody wants. Instead of maximising your yield, a cheaply-built granny can have the opposite effect on the overall value of your home.

If you’re planning to build a granny flat, focus on quality to ensure you attract the most tenants and buyers down the line.

Local council may impose restrictions

You need to make sure that the granny flat conforms with the local council building requirements.

In some cases, council will deny your development application due to zoning so it pays to check out what you can or cannot do before hand.

For example, if you already have a granny flat on your property but have the space for another, you may decide to go ahead and build it.

In this way, you hope to maximise your rental income by having another tenant.

What often happens in these cases is that the second granny flat is identified as an “outbuilding” in the valuation report rather than a liveable granny flat with an address.

It’s usually because the second granny flat is smaller, doesn’t have an appropriate frontage and is built as an attachment to the main dwelling.

Potential oversupply

Due to the current popularity of a granny flat strategy, some suburbs are turning into granny flat ghettos where there are simply too many granny flats available relative to demand.

This can negatively impact the rental and capital growth potential of your property.

Just like buying an investment property, make sure that you conduct comprehensive research to ensure that there’s limited supply of granny flats in the area both in the current market and in the future.

Limited demand

The simple truth is that not every tenant wants to live in someone’s backyard. What this means is that a granny flat has a limited rental market.

Make sure you speak to the local real estate agents about demand for granny flats in your suburb and how much rent they’re fetching before you build one.

Over-capitalising

This is easy to do with any construction or development. You could run out of money before you finish building the granny flat.

Make sure that you set aside enough buffer for you to be able to complete the construction.

Building a granny flat could just be what you need to boost your rental yield and equity rapidly if you do it right.

Tax implications of granny flats

The family home is generally exempt from capital gains tax (CGT), but your granny flat may not be.

Whether your property is exempt or not depends on how you use the flat. Generally speaking, if you’re renting the flat out to a third party, this would be considered commercial rent, meaning your property could become partially liable to CGT in the event of a sale.

Interestingly, following the 2020 budget announcement, the government plans to scrap capital gains tax for granny flats, where there is a written formal agreement with relatives who are older or are living with a disability. As always, please seek qualified financial advice from a qualified accountant or financial advisor regarding taxes.

Get the specialists on your side!

Our experienced mortgage brokers can help you get the granny flat loan you need to get your project off the ground.

Please call us on 1300 889 743 or enquire online and we will work out which lender can assist you with your granny flat investment.