When looking to find the ideal loan structure for your investment property portfolio, don’t fall into the trap of being lured into attractive sales jargon and pretty pictures.
Optimal home loan structuring can save investors interest, tax, and provide better financial security for your future property investments.
In this article, we will cover six tips to consider when structuring your home loan:
- Diversify your lenders
- Open an offset account
- Borrow the maximum
- Interest only versus principal and interest loans
- Fixed rate versus variable rate loans
- Get advice on loan structuring
Diversify Your Lenders for Property Investments
Don’t be afraid to branch out.
Different lenders value properties differently. The most obvious reason to shop around is to find the best deal with the best rates.
If you already have a relationship with a lender, you don’t need to use them for everything. If a lender knows too much about you and your personal business, you run the risk of them having too much control when you apply for an investment property.
They also might become “lazy” in knowing that you will take whatever they propose and won’t work to give you the best possible loan option.
Although using one bank for your private and business banking might seem convenient and can indeed be when things are going well – problems are likely to arise when things go south.
Open an Offset Account
Using an offset account on your investment property is a way to reduce interest ( Assuming you have no owner occupied debt).
This everyday transaction account is linked to your home loan. You can deposit money into this account from your salary and/or your savings, and the balance is offset against the outstanding amount of your loan.
By doing this, you are only being charged interest on the difference between the amount of your offset and the balance of your home loan.
Borrow the Maximum and Use an Offset
A major misconception Australians have is that it’s a good idea to put a large deposit down and take out a small loan.
The problem comes in when you want to take out another loan later and cant due to changes in your financial situation.
The better option is to take out a loan for your maximum borrowing capacity and put the money you would have used as the deposit in the offset account. If you took out a loan for $500,000 and deposited $100,000 into your offset account, you will only be charged mortgage interest on the remaining $400,000.
By doing this, you also have readily available cash flow for emergencies, rather than having it tied up in the property. The $100,000 in your offset account can be easily withdrawn and used for renovations and upgrades should you want to do so. If it were already in your mortgage account, you would have to set up a cash-out policy or a redraw facility in order to access that money.
Interest Only Versus Principal and Interest Loans
Which one of the two you decide on is dependent on how your goals and plans.
Principal & Interest Loans
With P+I loans, you pay interest as well as the original amount you borrowed mortgage. They usually come with a fixed-term timeframe, after which the loan will be fully paid off generally 30 year loan term..
The benefit of this type of loan is that your interest decreases over time as the value of your loan decreases due to the loan repayments.
As the interest goes down on a P+I loan, the negative side of this is the amount you can claim as a tax deduction will also decrease.
Interest Only Loans
With IO loans, you set a period of time to pay only interest, generally up to 5 years – without paying down the principle loan amount the mortgage.
Once the period of your IO loan is complete, your IO loan becomes a P+I loan. Then you begin to pay for your mortgage and interest together.
The mortgage amount remains unchanged over the time you are paying the interest only.
Provided that interest rates remain the same, you can consistently claim the maximum amount of interest of an IO loan as a tax deduction.
If you choose the IO option, you can use the excess money you would have paid towards your loan principal as savings in your offset account. Remember, the more money in your offset account, the lower the amount that you are charged interest on.
IO loans can take longer to pay off because during the time you are paying IO, you are not contributing anything to your mortgage.
You should also be aware of the large increase that will occur from what you were paying during IO and once you begin with P+I.
Fixed Rate Versus Variable Rate Loans for Property Investors
Choosing how your interest rate plays a part in your home loan structure is crucial for numerous reasons. The sum of money you will end up paying in the long run, as well as the terms and conditions linked to each, are important things to consider.
Fixed Rate Loans
A fixed loan allows you to plan efficiently and budget for the future as the amount payable doesn’t fluctuate. The interest rate is decided upon and added to your monthly mortgage repayments. You then pay that same amount until your loan has reached full term.
But, do take note that you may not be able to pay additional money to settle the loan quicker – you have to honour your set amount. This can be a make or break factor for many people.
A good time to choose a fixed rate loan is if interest rates are unusually low. Choosing a fixed loan structure means that your interest won’t increase over time as the markets go up.
Variable Rate Loans
While a variable rate loan offers more flexibility in terms of additional payments, future planning and budgeting are not that easy since your monthly mortgage will increase if/when interest goes up.
A variable rate loan is best if you are a “go big or go home” kind of person. It sure is a gamble, because what if interest rates go up – but the benefit of a variable rate is, what if the rates go down. You could land up paying substantially less than people locked into a fixed interest rate.
It is also in your best interest to choose a variable rate loan if you have cash injections that you can put towards the loan over and above the monthly repayments. This can help you save on interest over the life of the loan, and allow you to pay your investment properties off faster.
Save Money by Getting Advice on Home Loan Structuring
Paying for financial advice will cost you money in the short term. Strategically structuring an investment property loan can save you thousands of dollars in the future.
At The Mortgage Agency, we save you time and effort by dealing with all the parties involved for you – from financial planners to real estate agents, banks, to solicitors. We find the best loan products suited to your personal finances so that you don’t have to.
Our trained professionals can walk you through your property investment journey and provide tax advice, interest rate management advice, and strategies to increase capital growth.
The ideal loan structure is not one-size-fits-all. Instead, it is up to you to find your ideal loan structure for your investment property that suits your own personal needs and borrowing capacity.
There are some general rules that could be applied to almost all property investors, such as:
- Diversify your lenders;
- Open an offset account and invest your wealth into it;
- Borrow the maximum amount.
- Choosing an IO or a P+I loan;
- Choosing a fixed rate or a variable rate loan.
The Mortgage Agency is a one-stop-shop for all property investors’ financial queries and concerns. Contact us today to guide you on your journey of becoming a successful property investor.
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.