You can choose from various different features and options when it comes to investment property loans, so understanding and utilising them correctly can make a big difference in your financial future.
Before signing on the dotted line, you’ll need to decide what you want to get out of your investment loan to determine which format and features to go with.
We’ve isolated the most important things to consider before taking out a home loan for property investment.
1. Using Equity From Existing Properties
Most people choose to take out a home loan using the equity from another property they own.
You can apply to access the equity once you’ve paid off a substantial portion of that property’s home loan, and use that equity towards the deposit on your new home loan.
Equity acts as a security blanket for if you default on your mortgage. If you have enough equity, you can waive lenders mortgage insurance (LMI) costs.
You can access the equity from your property by refinancing its home loan. In the process, you might score a new interest rate that’s lower and save money as a result.
2. Property Investments Versus Owner Occupier Home Loans
If you don’t have another property or your home equity isn’t enough, you can apply for a home loan for property investment. These loans are quite similar to standard home loans with regards to the features and structures they offer.
Investment property loans can potentially be somewhat more expensive than owner-occupier home loans due to higher interest rates.
While both types of home loans generally require lenders mortgage insurance, property investment loans often only offer a maximum borrowing amount of 90% of the purchase price, while owner-occupied loans can offer up to 97%.
3. Structuring the Loan
There are two options on how to structure your investment property home loan repayments.
- Interest-Only Period
The loan can be split into two parts: an interest-only period at the beginning where you only pay towards the interest of the home loan, and once that term is complete, it rolls over to principal-only.
- Principal and Interest
This repayment structure entails paying for both the principal and interest portions of the home loan simultaneously for the duration of the home loan term.
Which One Should You Choose?
It’s wise to base your choice according to your current available cash flow, as well as your financial goals.
Principal-and-interest repayments are stable and structured as the amount remains the same for the full duration of the loan term.
On the other hand, the interest-only period usually amounts to less money per month, so you can save that money you would have spent on mortgage repayments, or use it for investment purposes in the short term.
Investors sometimes structure their interest-only repayments so that they can pay them in advance. Instead of making monthly interest-only repayments, they pay all twelve repayments at the beginning of each year until all the interest is paid off. This is a strategy used to bring forward tax-deductible interest repayments, effectively reducing your taxable income.
4. Choosing the Most Suitable Interest Rates For Your Home Loan
Home loans for investment properties have the option of fixed or variable interest rates.
- Fixed Interest Rate
Interest rates that are fixed don’t change: they lock in the interest rate as it stands when you sign up for your loan. Choosing this option can be advantageous if the interest rates are low at the time of signing: it guarantees that your rate will remain unchanged even if the rates go up.
- Variable Interest Rate
The opposite is true of variable interest rates: they fluctuate along with the cash rate. This option can be a gamble, because you’ll benefit when rates go down, but you’ll also have to pay more if the rates go up. Many people choose to bear the risk because these loans typically offer additional features that we will discuss in more detail below.
You may want to apply for a split loan option, which combines the two interest rate structures. Your loan is divided into a period with a fixed-rate, and then another one with a variable interest rate during different times of the loan.
5. Variable Interest Loan Features
A home loan with a variable interest rate comes with two available features. These features work somewhat like a savings account that’s linked to your home loan account. You can make extra lump sum repayments or pay a little extra every month along with your mortgage, and the money will be offset against your home loan – and you can withdraw the money to use at a later stage.
- Offset Account
Borrowers can access the money in their offset account easily and freely like a transactional account at no extra cost.
- Redraw Facility
While a redraw facility is similar, you aren’t able to access the funds as easily. This option is better for those who may be lacking a bit of self-discipline, as you need to apply to access the money in your account and it can take a few days to be approved and released.
When you buy an investment property, it’s a long-term commitment so you need to ensure you choose the home loan that best suits your financial situation and goals.
Some of the options to choose from include:
- leveraging the equity from another property you own to pay the deposit,
- a mortgage that’s interest-only or principal-and-interest simultaneously,
- fixed or variable interest rates, or a combination of the two, and
- features offered with a variable interest rate such as an offset account or redraw facility.
Managing and planning an investment home loan needs understanding and patience. Employing the help of a financial advisor can useful, and a mortgage broker can assist you with the decision-making as well.
Having a professional to walk you through the loan application process will set you up on the road to success, and guide you throughout every step of the journey to becoming an investment property owner.
Tony is the director of The Mortgage Agency based in Sydney. He is specialising in a holistic approach to home loans to help the clients with getting the right outcome based on their specific financial circumstances.