Risk. Those four letters make the finance world turn around. How much risk is involved in any transaction will determine how much it costs … it’s also a measure of the reward if the risk pays off.
Risk also explains why it’s easier to get finance for an owner-occupied property than for an investment property.
On the face of it, investment and home loans look similar. They both tend to have features such as 100% offset, interest-only repayments and redraw facilities. You can get basic investment loans, lines of credit and professional packages. Discounts for both are also available.
But there are differences than prospective investors need to be aware of.
Why take out an investment loan?
Investment loans can be rewarding for investors looking for passive income. They can help diversify or consolidate an investment portfolio.
In addition to the promise of high capital and income returns, investment properties might offer important tax benefits. The interest you pay on an investment loan is tax deductible. This, in turn, can lower the holding costs for your property.
With an investment home loan, you might be able to borrow more than you can with a standard home loan. This allows you to buy a property, turn it into a lucrative rental business and move in later. You also create equity that allows you to invest in other business ideas.
Some borrowers choose to buy an investment property before they actually buy a home.
Negative gearing occurs when the running costs on your investment, as well as your interest, surpass your investment income. It is calculated at the end of the year. With a high taxable income, the benefits of negative gearing can exceed your holding costs.
This strategy might help you to increase your investment income over time to make up for other expenses. Until that happens, you may turn the net loss into a tax deduction against your other income.
For more information about negative gearing, you should seek professional financial advice.
Why are investment loans so hard to get?
Most lenders see investment loans as risky, which is why they tend to be selective about who they lend to. They scrutinise a potential investment borrower’s credit history, and employment and savings records. They generally want to see at least 5% of the loan amount in genuine savings (the more the better) and equity in other properties, especially if your loan to value ratio (LVR) is greater than 90%.
When banks need to sell an investment property to recover debt, they often run into problems with tenants – some refuse to move out, others get angry and damage the property. Lenders also know that if you run into financial difficulties, you’re more likely to continue to pay your home loan rather than your investment loan.
Interest-only investment loans can allow for a better cashflow in the short term, although uno research has shown that they are unlikely to be your best option.
Investment property types and requirements
Financial institutions are picky about what types of investment property they will loan money for.
Generally it needs to be house, townhouse or standard unit in good condition with a living area greater than 50m². It should be located in a major city or town with more than 10,000 people.
How much can I borrow for an investment loan?
With the right investment lender, you could borrow 95% of the purchase price. This means you may only need a 5% deposit and a similar sum for purchase costs.
If you borrow less than 90% of the property value, lenders consider you a lower risk borrower and getting approval is likely to be easier.
Other things to consider:
- Some lenders use 100% of your rental income in their evaluation, while others use only 80%.
- Most lenders add up to 2% to the current interest rate to calculate your borrowing capacity. They do this to make sure you can withstand increases. Others use the actual rate if it is fixed for three years or more.
- Some lenders use both principal and interest repayments on your debts, even if your application starts off with interest-only repayments.
- Not all lenders consider your negative gearing benefits when calculating your ability to repay the loan.
You might consider fixing the current interest rate or looking to buy geared investment properties. Also, you can apply jointly with your spouse, so that the lender assesses your combined income.
Up-front investment property costs
- Valuations: The property you want to purchase may require a valuation, inspection and property research. These surveys inform you about the property’s market worth and rental potential.
- Stamp duty: Varies from state to state but can be as high as 6% of the property price.
- Property title: After you buy the property, you need to transfer the property title on your name.
- Legal fees and conveyancing costs: Usually paid for home purchases, these aren’t always mandatory for investors.
Ongoing investment property costs
- Maintenance: You have to pay for repairs, replacements, and other services. These may include plumbing repairs, pest control, or fixing broken windows. While property maintenance is tax deductible in Australia, aesthetic improvements are not.
- Rates: If you rent out your investment property, you need to pay the water bill and other council rates and taxes.
- Levies: You may have to pay fees to those who use funds for the maintenance or repair of the property.
- Insurance: Most properties must be insured against damage. However, you can have control over the extent of the insurance and, therefore, over the cost of the insurance.
- Interest: Interest on an investment property can be expensive. It’s important to factor it in when calculating rental income from your property.
- Agent fees: Unless you manage the property yourself, you may have to pay fees to the agent who does.
What to do next
uno is your go-to service for all types of online loans, including investment home loans. If you’re wondering “How much can I borrow?” or need an accurate loan calculator, we can help.
This information is general in nature, and you should always seek professional advice when making financial decisions.