When getting an investment property loan, understanding how interest rates work is crucial because it can help you assess your financial risks better, identify the best products available according to your needs, and determine the most cost-effective time to get a loan.
In this article, we’ll dive into how interest rates are determined for investment property loans and what strategies you can use to secure the best rates.
Factors Affecting Interest Rates on Investment Property Loans
Interest rates for investment property loans in Australia are influenced by a variety of factors:
- Risk Profile: Investment property loans are typically seen as higher risk, prompting lenders to charge higher interest rates compared to loans for owner-occupiers. This risk is due to factors like the potential variability in rental income and the possibility of vacancies. Moreover, investment properties often rely on market conditions for profitability, making them less stable than a primary residence, where income sources might be more predictable.
- Loan Features: The type of loan features available can also affect the interest rate. Options like offset accounts, the ability to make extra repayments, and interest-only payments might offer flexibility but could come at the cost of a higher interest rate.
- Fixed vs. Variable Rates: Borrowers can choose between fixed and variable rates. Fixed rates provide stability in repayments and are insulated from rate increases during the fixed period, but they may miss out on savings if rates decrease. Meanwhile, variable rates can fluctuate with the market, potentially offering lower rates initially but with the risk of increasing over time.
- Economic Factors and Reserve Bank of Australia (RBA) Decisions: The broader economic environment and decisions by the RBA on the official cash rate significantly impact interest rates across the board, including those for investment properties. For instance, when the RBA sets a low cash rate, borrowing costs tend to be lower, and vice versa.
- Lender Competition and Loan Terms: Competition among lenders can also influence the rates offered. Shopping around can often help you get better rates, as different lenders have varying appetites for investment loans at different times. Terms of the loan, like the amount borrowed and the loan-to-value ratio (LVR), also play crucial roles. A lower LVR generally results in a lower risk for the lender, potentially leading to more favourable rates.
- Borrower’s Financial Stability: Last but not least, your financial stability plays a crucial role in the interest rates of your investment property loan. A stronger credit profile can secure you lower interest rates, as it reduces the perceived risk for the lender. Lenders assess your credit score, income stability, and debt-to-income ratio to gauge your reliability as a borrower. Additionally, the size of your deposit significantly impacts the rates offered.
Strategies to Secure the Best Rates
To get the best rates for your investment property loan in Australia, consider the following tips:
- Boost Your Deposit: Aim to save at least 20% of the property’s value for your deposit. A larger deposit not only reduces your need to pay for Lenders Mortgage Insurance (LMI) – an insurance policy that protects the lender if you fail to repay the loan – but also potentially qualifies you for lower interest rates, as it lowers the lender’s risk.
- Assess Your Financial Situation: Get a clear picture of your income and expenses by creating a detailed household budget. Understanding your disposable income is crucial, as it determines your ability to handle the ongoing costs associated with an investment property.
- Enhance Your Borrowing Power: Your ability to secure a favourable loan is enhanced by a strong financial profile, including a stable income, a solid employment history, and a good credit score. Regularly review your bank statements and consider how you can improve your financial standing.
- Use Equity Wisely: If you already own property, consider using the equity built up in it as a deposit for your investment property. This can increase your borrowing capacity and potentially enable you to make a larger initial investment.
- Get Pre-Approved: Loan pre-approval gives you an understanding of how much you can borrow before you start looking for a property, which can make your search more efficient and strengthen your negotiating position with sellers.
- Choose the Right Loan Type: Decide between interest-only and principal-and-interest loans based on your investment strategy. Interest-only loans can reduce your monthly outgoings initially, which might be beneficial if you expect property values to rise. On the other hand, principal-and-interest loans reduce the loan balance and total interest paid over time.
- Compare Loan Products: Don’t settle for the first offer from your existing bank. Check options and compare interest rates, fees, and loan features from various lenders, including smaller banks and non-bank lenders who might offer more competitive rates.
- Consider a Guarantor: If your deposit is not substantial or if you want to enhance your loan application, consider using a guarantor. This can help you avoid LMI and possibly secure a lower interest rate.
- Optimise Loan Features: Look for loans that offer features beneficial to investors, such as offset accounts and the ability to make extra repayments without penalty. These features can help manage loan costs effectively over time.
- Professional Advice: Consult with a mortgage broker who can offer access to a wider range of products and exclusive deals. They can also give you professional advice based on your financial situation and objectives.
Final Thoughts
Understanding how interest rates work and implementing the abovementioned strategies will help you secure the best possible terms for your investment property loan, minimising costs and enhancing your potential for a successful investment.
If you’re planning to obtain an investment property loan, consider reaching out to a mortgage expert for more detailed guidance and a personalised loan strategy that aligns with your investment needs and goals.
