When purchasing a house, your motivation for the purchase determines whether you’ll need an investment loan or a home loan. If the house is going to be owner-occupied, you’ll need an owner-occupier mortgage. If the property is to be used as an investment, you’ll need an investment loan.
Do I need an investment loan or a home loan?
When it comes to borrowing to buy a property, the first thing the lender will need to know is whether you are going to be living in the house or if you’ll be using it as an investment. If you are choosing to live in the home, you will need an owner-occupier loan. If you are going to rent the house out or do it up to sell for a capital gain, you will need an investment loan. It’s important to differentiate between the two types of loans as they are treated differently when it comes to tax and lending criteria. The different criteria and product style between investment loan vs home loan means that there is generally a price disparity between the two options; owner-occupied loans generally have a lower interest rate and less fees than an investment loan. But this doesn’t mean you can simply choose a home loan to purchase an investment property because the interest rate might be less. A loan relevant to the purchase type is necessary.
Don’t be tempted to try to get an owner-occupier loan for an investment property just because it’s cheaper. Lenders are always on the lookout for occupancy fraud and the consequences aren’t worth the risk. Investment loans generally have a higher interest rate purely because investments are seen to have a higher risk of default. The lender needs to be compensated for taking on this perceived level of additional risk.
What are the differences between an owner-occupier mortgage and an investment loan?
LVR
Due to stricter lending criteria for investments, some lenders may only offer a Loan to Value Ratio (LVR) of 80%. This means you would need to come up with a 20% deposit either through savings or existing equity to be considered for an investment loan. However, this is not always the case; you may be able to find a specialist lender who will offer an LVR of up to 95% — which is what many lenders offer for owner-occupier home loans. A higher LVR however does come with a higher rate usually, but if the investment makes sense after paying a higher interest rate then the higher rate can be irrelevant.
Tax treatment
An investment property is an income producing asset, so it makes sense that you can claim a tax deduction for the interest expense. You are unable to claim a tax deduction for interest expenses incurred due to repaying a home loan, as you aren’t generating any income from your home — you’re simply living in it. Selling a property is also taxed differently depending on whether it’s your family home or an investment. Any gain made through the sale of an investment property will be subject to Capital Gains Tax (CGT), whereas any capital gain from sale of the family home does not incur CGT. At face value, an investment loan may seem more expensive, but once you take into consideration the tax deductions available, it quite possibly could end up cheaper than an owner-occupied mortgage depending on your taxable income.
Lending rules
An uncertain economy has seen lending criteria tighten up for investors. This has not only made it more difficult to get an Investment Loan, but also more expensive when it comes to interest rates and fees. But don’t let that deter you from investing. Investing in property can be a great way to generate a high return — the tighter rules and higher cost doesn’t mean your investment won’t be profitable!
Home loan top tips
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Think about your rental strategy
Before buying your rental property, think about what your strategy is going to be with regard to your new property. Are you buying it with the intent of getting a steady additional income from the rent, or is your intent to negatively gear it to relieve the burden of a large income tax bill? Plan your investment strategy before you buy. Remember the three R’s in real estate: make sure you buy the right property in the right location for the right reasons.
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Plan what you’ll do if your rental property suffers expensive damage
Make sure you have extensive landlord insurance to cover every eventuality that could go wrong with your rental property. Think about what you’d do if your property became uninhabitable due to a flood, bushfire or another natural disaster. Ensure your landlord insurance covers all eventualities, including the potential loss of rental income for an extended period whilst major repairs are undertaken.
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Do you have time to manage your rental property yourself?
Is your rental property located conveniently nearby to allow you to keep an eye on it? Are you able to respond immediately if your tenants request an urgent repair job done, or would you be better off employing a property manager to care for your rental on your behalf? If you don’t have the time and availability to look after your property and your tenants, you should budget to employ a property manager right from the start, rather than waiting until a crisis happens and your tenants are left in a tricky situation because you’re unable to get urgent repairs done.
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Don’t squeeze your finances too tight
Don’t plan your finances so tightly that any slight variation causes you financial distress. The fact is that tenants may not always be reliable, for reasons within and outside their control, so allow yourself some financial breathing room. You shouldn’t rely on your weekly or monthly rental income to such an extent that one late payment leaves you unable to pay other important bills. It’s vital to plan carefully so that you’re able to ride the ups and downs of life without mortgage stress taking its toll on you.
