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What is an Investment Home Loan?
An investment loan is a mortgage on a property you intend to rent out. Becoming a property investor isn’t just for jet-setting millionaires; anyone who can buy a property can become an investor.
Once you have an investment home loan, you can earn rental income by getting tenants. There are also a number of tax breaks involved, which can make investing more affordable and help combat negative gearing.
How is an Investor Loan Different From an Owner-Occupier Home Loan?
There is a higher level of risk associated with investor property loans, and that is reflected in a lender’s interest rates, fees, and assessment process. When a lender assesses you for an investment loan, they want to be sure you can meet the repayments at the current interest rate and a higher one.
Investment loans may also be structured differently than owner-occupier loans. For example, many investors take advantage of the available interest-only period.
With interest-only payments, you pay only the interest for a fixed period. During the interest-only period, your principal (the amount of the loan) stays the same.
This option means lower repayments, but you will pay more over the life of the loan (see our example below). As an investor who is writing interest off as a tax deduction, this is less of a concern than it might be for an owner-occupier.
Monthly repayments when reverting to principal + interest: $2,329
Total cost: $678,772
If he had chosen principal + interest payments for the entire loan period, the repayments would have been $2,223.
Total cost: $666,999
The interest-only period costs Bill an extra $11,773 over the life of his loan.
As owner-occupier loans tend to be cheaper than investor loans, some investors are tempted to lie about their intentions in an attempt to save money. Telling a lender that you intend to occupy the property when you actually intend to rent it out is occupancy fraud, also called mortgage fraud.
Understanding Investment Home Loan Rates
Investment home loan rates tend to be higher than owner-occupied home loan rates. However, the Australian Prudential Regulation Authority (APRA) recently relaxed restrictions on investor loan growth, and may also loosen its 30% cap on interest-only lending. This could mean that the gap between investment home loan rates and owner-occupier home loan rates may start to close.
Fixed rate loan: lock in a low interest rate, usually for around 1 to 5 years
Variable rate loan: rate fluctuates based on the RBA cash rate and your lender’s rates
Split rate loan: part of your loan is variable, part is fixed
Know your repayments
Rate cannot go up
Rate cannot go down
Fees may apply to exit early
Possible restrictions on extra repayments
Flexibility on extra repayments
Offset accounts may be available
Rate can increase at any time
Keep part of your loan variable
Make extra repayments on variable portion of your loan
Fees may apply to restructure the loan before the fixed term ends
Understanding Investment Home Loan Rates
When you shop online for investment property loans, you may see two different interest rates shown: the interest rate and the comparison rate. There are a number of fees and charges associated with maintaining a home loan, and these costs are rolled into the comparison rate to give you a more accurate picture of your overall costs.
While it can be tempting to look at interest rates as the sole deciding factor, fees and charges can have a significant impact on your overall loan costs.
Lenders may offer special low introductory rates to entice you into a home loan. While these can be worthwhile, always find out what the rate will be after the introductory period ends. If it is too high, it may not be balanced out by the initial savings.
Investment Loan Repayment Options
You’ll also need to consider your repayment structure, and decide whether you’d be better off with an interest only or principal + interest loan.
Interest-only repayments: Your repayments cover the interest accrued. This means lower repayments in the short term, but you’ll usually pay more over the life of your loan. However, this is often offset by the tax advantages associated with an investor loan, as interest can be considered a tax deduction. If your property’s value increases, it could balance out the interest-only period.
Principal + interest repayments: Your repayments will be higher, but they are also reducing your principal, meaning you’re paying off your loan more quickly.
Variable 5.79% interest rate
Total interest over life of loan: $444,008
Remainder of loan term: $1,263
Total interest over life of loan: $473,631
When shopping around for an investor home loan, you’ll probably come across the term LVR, or ‘loan-to-value ratio’. This is the amount you need to borrow in relation to the property’s value, and is usually expressed as a percentage. The higher your LVR, the more money you’ll need to borrow.
Here’s how to calculate LVR, using a $400,000 property and $70,000 deposit as an example.
- Subtract your deposit from the property value to establish how much you’ll need to borrow
E.g. $400,000 – $70,000 = $330,000
- Divide the amount you need to borrow by the property value
E.g. $330,000 ÷ $400,000 = 0.825
- Multiply that figure by 100 to get your LVR
E.g. 0.825 x 100 = 82.5% LVR
Lenders generally prefer investors with an LVR of 80% or less, which means you need to have a minimum 20% deposit. However, this is not a hard and fast rule and there are ways around it, such as enlisting a guarantor or by purchasing Lenders Mortgage Insurance.
Investment Home Loan Features
Investment home loan features are similar to those offered with owner-occupier loans, and they can be used to save you money.
Offset account: Transaction account linked to your home loan that offsets the interest on your home loan.
- Extra repayments: Make additional repayments to pay off your loan in a shorter period of time.
- Redraw facility: Withdraw extra payments if you need cash.
- Flexible repayment options: Decide whether you’d like to make repayments weekly, fortnightly, or monthly.
- Loan top-up: If the property value has increased, getting a new valuation can allow you to increase your loan amount and access those funds to purchase another property.
What is Negative Gearing?
There’s plenty of talk about negative gearing when it comes to investment loans. So what is it and how does it affect you?
Negative gearing is what happens when the cost of servicing the loan and the property is more than your rental income. Basically, it means that you’re making a loss on your investment property.
One advantage of being an investor is that you can then claim your interest and property maintenance costs as tax deductions, which can help to recoup some of your losses.
Her total expenses, including mortgage repayments, fees, and council rates, are $31,500.
As it stands, Susan is making a loss of $5,500 on the property. This is negative gearing: Susan has borrowed to invest and she is making a loss.
However, the total for Susan’s maintenance fees and interest payments comes to $11,000 for the year. This helps minimise her losses as she can claim these costs on her tax return.
Comparing Investment Home Loan Rates
Saving money on your investment home loan starts before you even start looking for properties. Shopping around for a good deal is one of the smartest ways to save. It lets you get an idea of market rates for investment home loans, so you can assess whether or not you’re getting a fair price.