Investment Property Home Loans
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If you’re thinking about your first or a new investment property, getting the right finance in place is going to make all the difference. Investment is all about exploiting margins, and finance is the key to making the most of any property’s potential.
Whether you want to play the long game and make money on your new property’s value, gain a regular rental income or benefit from both those things – having access to a competitive property investment loan can help you generate wealth.
How do investment property home loans work, and how are they different from owner-occupier home loans?
Like with any mortgage, investors agree to borrow a set amount over an agreed period and the lender registers an interest in their property until the loan gets fully repaid. In structure, investment and owner-occupier loans are similar, but you’ll notice a couple of differences immediately:
- The interest rate:
One of the primary differences between an owner-occupier home loan and an investment home loan is that investors pay a higher interest rate than owner-occupiers. That’s because investment properties are considered higher risk than owner-occupied homes.
- LVR and down payments:
As an owner-occupier, you can get a low-deposit home loan with up to 95% LVR, but investment loans are different. Most lenders require you use a minimum 80% down payment.
The qualification requirements for investor loans are different too:
- Your existing financial commitments come into play with any finance application, and a second mortgage can be harder to qualify for than your first. Lenders vary, but some will take part or all of your expected rental income into account when you apply for an investment property home loan. They may also consider the expected capital growth. Both those things can affect your loan to income ratio favourably.
- Be aware, however, that for the loan provider, an investment loan is not just about the structural integrity and value of the building like with an owner-occupier application – your investment needs to be viable. The lender will scrutinise its type and the location.
- In some cases, mortgage providers will extend that assessment to vacancy rates in the neighbourhood where you want to buy. With rental property loans, it’s crucial to examine yields in different areas and avoid buying where there’s a glut of options for tenants or a lack of tenants in general.
Fees for investment property loans are pretty much the same as with owner-occupier versions – with the exception that valuation fees can sometimes be higher. Lenders charge an establishment fee, and monthly or annual account fees. Remember, just like with an owner-occupier loan, if you refinance or pay down investment property loans early, a break fee will apply when you’re using a fixed interest rate.
Another difference of note between these two home loans is that under the right circumstances, it can be easier to use interest-only repayments with an investment property mortgage. Most lenders will want to verify that doing so is part of a viable wider strategy, but it’s generally far easier to use this feature than when using an owner-occupier home loan.
Can I use my home equity for my investment property home loan?
Yes – you can do this through an equity line of credit. A line of credit works by giving you access to the equity in your property. Whenever you use a line of credit facility, you’re essentially borrowing against your home. That keeps the interest rate far lower than with an unsecured loan or a credit card – and property even pips vehicles when it comes to being a lender’s preferred method of security for borrowing.
Investors sometimes use equity as part of a compound growth strategy, which is basically reinvesting the profits from a capital growth strategy to build more wealth. While this promotes the generation of wealth, it’s important to be aware that compounding takes time to build and you may need to supplement such a plan for a little while with your own funds.
A line of credit can also be instrumental in managing some of the planned and unexpected costs of maintaining a property. Having a line of credit in place saves you the hassle of arranging finance every time something comes up, especially when you need to act fast to remedy a problem.
The lower interest rate aside, the way a line of credit home loan works is comparable to a credit card. You spend when you need to, and you only pay interest on the equity you’ve accessed, not the limit of the facility.
How can I compare investment property home loans?
Investors typically look at home loans a little differently to owner-occupiers because fees are tax-deductible and property loan interest rates are higher – plus that element is tax-deductible too.
That’s not to say that all investment property mortgages are the same, however. It’s still important to compare lenders and products like-for-like and you might want access to home loan features like line of credit or redraw facilities.
You can compare hundreds of investment property home loans with Savvy. It’s easy to use our comprehensive tables, then instantly examine features, check rates and fees, and find your ideal solution.
What is negative gearing, and how can I make it work?
If you’re buying a second home, you stand to make a profit on two fronts – the rental income and capital growth – but that doesn’t always happen, and some investors don’t even plan for it to occur.
The ‘gearing’ in negative gearing just refers to borrowing money for an investment. The ‘negative’ is when rental income doesn’t cover the cost of rental property loans. If your rental income did cover your expenses, then the property would be ‘positively geared.’
A property investment is often still viable when it’s negatively geared for a couple of reasons:
- Capital growth – which is basically how much profit you make from the increasing value of your investment during ownership.
- Tax-deductions – because Australian investors get to deduct any negative gearing losses from their income at tax time.
What that means is that you can run your investment at a loss but you’ll still be in the black as long as you make an overall profit when you sell. Essentially, so long as the increase in value is greater than your losses during ownership, it’s a good investment. Let’s look at a successful example of negative gearing:
| Loan: | Interest rate: | Monthly: | Monthly rent: | Annual loss: |
|---|---|---|---|---|
|
$300,000 |
7% |
$1,995.91 |
$1600.00 |
$4,750.92 |
In this example, the investor buys a two-bedroom unit in a very commutable outer city suburb for $400,000. Because the neighbourhood is likely to continue producing good capital growth, the investor can find a loan with a relatively high LVR of 75% and a reasonable 7% interest rate, while using a $100,000 deposit.
The local train station means this unit is only a 25-minute ride from the CBD, so rental demand in the area is good. That being said, the unit is never going to produce CBD weekly rents.
One of the reasons capital growth in the suburb is high in the first place is because lots of investors want to buy, which drives up demand – and prices. It also means there’s no shortage of properties for tenants. That keeps rents down, so while the property is negatively geared, its value is rising all the time.
The investor here is relying on a capital growth strategy. They’re banking on the fact the property will increase in value over time and they’ll make money – plus they can deduct annual losses when they file their tax return.
| Capital growth rate: | Property value: | |
|---|---|---|
|
End year 1: |
6%
|
$424,000 |
|
End year 2: |
6% |
$449,440 |
|
End year 3: |
6% |
$476,404 |
|
End year 4: |
6% |
$504,990 |
|
End year 5: |
6% |
$535,290 |
Over five years, the investor chalks up losses of $23,754.60 (which they can deduct from their taxable income) but the property’s value continues to achieve 6% growth and rises by $135,000.
Investors must pay capital gains tax when they sell, but a good capital growth strategy can be extremely effective at generating wealth. Positive gearing and a cash flow strategy can look attractive, but you’ll often find good rental yields where capital growth is lower.
That means while the rent is likely to put some regular cash in your pocket in the shorter term, you’re not going to see the compounding benefit of a rising property price over five or ten years – and that can really put serious money in the bank once it gets snowballing. You’re earning on the investment each year, and on the interest on the original investment too. At times of low inflation, even a 4% capital growth rate is pretty strong, but a good rental yield might be nearer to 10% when relying on that cash flow strategy.
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