Time to read : 5 Minutes
Mastering property investing requires a good understanding of the main lending concepts which can shape your borrowing strategy.
While the 12 foundations of smart borrowing are far from a complete and comprehensive lending playbook – as lending is a complex and ever-changing landscape – having an understanding of these will help guide you through the borrowing process.
So here are 12 essential concepts every property investor should know:
1. Borrowing strategy
Your borrowing strategy is the blueprint for building a sustainable, multi-property portfolio. What’s important here is that it’s not just about securing loans. It involves setting the foundation for smart, strategic investing.
2. Loan structure
A well-designed loan structure is integral to your borrowing strategy. This includes loan splits that avoid 'cross-collateralisation', as well as factoring in additional borrowing for costs like stamp duty rather than using cash.
💡 Cross-collateralisation is when you use the same asset, such as a property, as security for more than one loan (at the same time). So if you're unable to repay the loans, the lender can repossess the asset to recover what's owed.
3. Borrowing capacity
This represents how much you can borrow based on your income, expenses, and current debt. It reflects what you can borrow now, but if done right, it should be shaped by an overall strategy rather than short-term tactics aimed at maximising capacity at all costs.
4. Principal and interest repayment type and terms
A mortgage typically has a loan term of 25 to 30 years, with repayments set on a monthly basis. For example, a 30-year loan consists of 360 monthly repayments.
Each repayment covers both the principal (the loan amount) and interest owed to the lender. Standard practice is to use principal and interest (P&I) repayments for personal property loans, such as your principal place of residence and holiday homes.
Ben & Bryce tip: changing the repayments from monthly to fortnightly can help reduce the overall interest paid and shorten the life of your loan.
5. Interest-only repayment type and terms
An interest-only (IO) repayment term is typically applied at the start of a 25 or 30-year mortgage for a set period– usually three to five years – before reverting to P&I repayments.
6. Interest rates
Interest rates can impact your cash flow, which can directly influence the costs of borrowing. Lower rates mean smaller repayments, while fluctuations can impact your financial strategy:
Variable rates
These can change at any time regardless of whether the RBA is due to meet or not. The benefit of a variable rate is it provides flexibility with repayments through offset and redraw facilities, and customers can take advantage of any potential rate drops. But variable rates don't provide security on the repayments.
Fixed rates
This is when you lock in a set rate for a specific period – typically one to five years, though some lenders offer terms up to 15 years. In most cases, loans are fixed for no longer than 5 years, with 2- to 3-year terms being the most common choice, as personal circumstances can and often do change.
Fixed rates are best for people who like to budget and know exactly what they are paying for the fixed duration. They can incur break fees if customers decide to come out of a fixed rate early.
At the time of writing, lenders apply different interest rates based on factors such as security type, repayment structure, and loan-to-value ratio (LVR). For example:
A 60% LVR loan secured against your personal home with P&I repayments would attract a lower interest rate.
Meanwhile, an 80% LVR investment mortgage with IO repayments would typically have a higher rate.
Ben & Bryce tip: stay in regular contact with your investment-savvy mortgage broker to ensure your lending remains competitive and aligns with your strategy.
7. Loan-to-value ratio (LVR)
LVR measures the loan amount relative to the property’s value. A lower LVR requires a larger deposit, reducing risk for both you and the lender. For example, a $560,000 loan on a $700,000 property equates to an 80% LVR.
Understanding LVR is crucial for determining your deposit size, current and future equity releases, and whether lenders mortgage insurance (LMI) applies.
8. Lenders mortgage insurance (LMI)
In most cases, LMI applies when your deposit is less than 20% of the property’s value, but ask your broker for further guidance.
It can help home buyers enter the market with a smaller deposit but adds an expense that can impact borrowing power. It is insurance that protects the bank, not you.
Ben & Bryce verdict: avoid it if you can but accept it if necessary to get ahead. Learn about the government help for first time home buyers that may help you avoid LMI.
9. Equity
Equity is the difference between your property’s market value and the outstanding loan balance. As you pay down your loan and/or your property appreciates, you build equity.
This becomes a powerful tool for funding future purchases and could accelerate your portfolio growth, minimising the need for cash deposits.
10. Offset account
These accounts can be requested to be linked to your home loan. The balance offsets your loan principal, reducing the interest calculated each day.
For example, if you have a $300,000 loan and $50,000 in your offset, interest is only charged on $250,000 instead of $300,000. This saves you daily interest on the $50,000 offset amount.
Having an offset is a powerful tool for reducing interest costs and paying off your loan faster, while preserving access to your cash. Unlike regular savings accounts (where ‘earned’ interest is taxed), offset accounts simply reduce the ‘expense’ instead.
11. Assessment rate
Lenders evaluate your ability to repay a loan using an assessment rate, which includes a servicing buffer usually between 2% to 3% above the lender’s market interest rate. It can on occasion with some lenders be as low as 1% for special refinancing situations.
This buffer helps protect against potential interest rate increases but also reduces your borrowing capacity. The assessment rate acts as a safeguard, ensuring both you and the lender can manage future financial risks.
12. Personal buffer
A buffer is your financial safety net – extra cash on hand or borrowed funds set aside to manage unexpected expenses, rising interest rates, or any short-term rental vacancies.
This liquidity helps you to be financially resilient and, importantly, gives peace of mind so you can navigate market changes without derailing your strategy.
Bottom line
Regardless of whether you’re thinking of investing in property now or in the next few years, choosing to invest in property is a big step that will involve lots of decisions.
These 12 essentials form the backbone of smart borrowing. Why not take a deeper dive and learn more about the fundamentals? They can help you to master smarter borrowing, faster.
Edited extract from How to Retire on $3,000 a Week: The Property Couch’s Playbook for Passive Property Investing (Major Street Publishing RRP $32.99) by Bryce Holdaway & Ben Kingsley.
Financial disclaimer
The information contained on this web page is of general nature only and has been prepared without taking into consideration your objectives, needs and financial situation. You should check with a financial professional before making any decisions. Any opinions expressed within an article are those of the author and do not specifically reflect the views of Compare Club Australia Pty Ltd.
