There are many differences between investor loans and a home loan for the property where you live.
Investors generally have different priorities than those buying a property to call home. As their mortgage interest charges and loan fees are tax deductible under a business expense, lenders often charge investors a higher interest rate to account for the risk. They’re also considered riskier borrowers, needing to meet specific lending criteria. As a result, investors structure their investment loans differently, in a way that’s strategic to their goals.
Additionally, if they already own a home, they may be eligible to use the equity to cover some of the expenses attached to the investment loan.
If you’re considering buying an investment property but aren’t sure how to go about it, here’s everything you need to know.
What is Your Borrowing Power?
Before you even begin looking at houses, the first step is to calculate your borrowing power. This calculation will help you determine how much you can afford to pay back every month towards your property investment in terms of principal and interest repayments.
Working out this amount means inputting:
- Your annual income
- Your monthly expenses
- The current interest rate
- The type of loan
- The loan term
Other financial commitments, such as existing debts, credit cards, and lease agreements, are also considered.
Remember, you’ll be responsible for covering ongoing costs as the property owner, such as repairs and maintenance, strata fees and council rates. Therefore, you need to have extra funds available each month for these responsibilities.
Can You Access Your Home Equity?
Equity is the difference between the value of the property you own and the amount still outstanding on your home loan.
Take note that to determine your home equity, you will have to get your property reevaluated to receive its current value.
Max bought his family home in 2010 for $700,000. He paid a cash deposit of $200,000 and secured a home loan of $500,000.
After paying his monthly mortgage for 12 years, he had made payments up to $200,000. Therefore, Max had contributed a total of $400,000 towards his investment.
During those 12 years, the property value increased to $800,000.
Max used the following formula to calculate how much he still owed:
Property’s original price – (Deposit + Mortgage amount paid so far) = Amount Outstanding
$700,000 – ($200,000 + $200,000) = $300,000
Next, he calculated how much equity he had in his property currently:
Property’s market value – Amount outstanding = Home equity
$800,000 – $300,000 = $500,000
The bank only allows owners to use 80% of their equity.
So, the following formula must be used:
(80% x Property’s market value) – Amount outstanding = Available equity
(80% x $800,000) – $300,000 = $340,000
Max, therefore, has $340,000 in home equity that he can use towards the deposit and other fees and charges associated with buying an investment property, including solicitor fees, establishment fees, and stamp duty.
If your home equity equals 20% of the new property’s purchase price, you won’t be charged the additional fee of lenders mortgage insurance (LMI).
How to Structure Investment Loans
Investor home loans have different features and repayment options available. You need to identify what interest structure and repayment type will work best for you and make the most of your investment.
Fixed Rate Home Loan
If a home loan has a fixed interest rate, the interest rate that the lender offers you on the day of signing will remain exactly the same for the entire life of the loan, regardless of whether the interest rate fluctuates.
Fixed-rate loans typically don’t offer any additional features.
An interest-only loan entails making interest-only repayments for a set period of time.
During this time, you aren’t paying off the debt owed on the property. The interest-only payments are typically lower and are claimable as a tax deduction. Once you’ve completed the interest-only period, your home loan repayments will increase as you begin to pay off your principal and interest simultaneously.
Using an interest-only home loan is a viable investment strategy because it allows investors to secure a property while they spend less on only the interest repayments. If the property’s value increases, they can sell it, use the money to settle the principal, and still make a profit.
Regarding tax, only the interest on an investment loan is claimable as a deduction. You may be able to pay the interest in advance each year to reduce your taxable income.
Variable Interest Rate Home Loans
Choosing a variable interest rate can be riskier because if the cash rate goes up, so will your home loan interest rates.
Property investors, therefore, need to consider whether they’ll be able to handle the increased volatility in the interest rate. If so, variable loans offer borrowers various additional features that can be highly beneficial.
An offset account is a transaction or savings account linked to your home loan account.
You can deposit money into this account, and it will offset against the balance of your home loan amount, meaning that the interest you’re charged is reduced.
You can either keep the money in the offset account for a rainy day, or you can use it towards paying off your investment home loan sooner.
Key Takeaways on Investment Property Home Loans
If you would like to take out an investment home loan, there is some homework you need to do first beyond understanding the interest rates.
Start by determining how much money lenders will be willing to offer you based on their eligibility criteria. Then, find out if there is any equity in your existing property that you can access.
Ask yourself: what is your loan purpose? Decide whether a fixed rate loan is better for you, which is where you make the interest repayments first for the fixed rate period, or if a variable rate is better because you want features such as a line of credit or offset account.
If you’d like some expert guidance throughout this process, The Mortgage Agency has home loan specialists that can assess your personal financial situation and help you on your way to investment property loan approval.
Contact our team today to get started.
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.