Getting a loan with the intent of buying an investment property requires a thorough understanding of various key factors that influence both your immediate financial commitments and long-term investment strategy. From deciding how much deposit is necessary to understanding the borrowing limits based on your financial circumstances, each element plays a crucial role in shaping a successful investment. Weighing the decision to borrow for investment purposes, knowing the higher interest rates applied to such loans, and choosing the right loan structure are steps that demand careful consideration as well.
On this page, we delve into these critical aspects, aiming to equip you with the knowledge needed to make informed decisions about investment property loans, and thus enhance your potential to achieve favourable financial outcomes.
How do investment property loans work?
An investment property loan functions similarly to a conventional mortgage, but with key differences. Standard home loans or owner-occupied home loans are designed for buying a property to be used as the borrower’s primary residence. On the other hand, investment property loans are specifically designed for purchasing properties intended to generate rental income or to be sold for profit. It’s essential to understand that these loans typically carry higher interest rates and may require a larger deposit compared to owner-occupied home loans due to the perceived higher risk by lenders.
Firstly, you need to determine how much you can afford to borrow and what kind of loan suits your investment strategy. Most lenders will assess your financial situation, including your income, existing debts, and credit history, as well as the expected rental income from the property. This assessment helps determine your borrowing power and the terms of the loan. You will typically need to provide a deposit, often at least 20% of the property’s value, to avoid paying Lenders Mortgage Insurance (LMI).
Additionally, an investment property loan can be either fixed-rate, where the interest rate remains constant over a set period, or variable-rate, which can fluctuate with changes in the market. Some property investors opt for interest-only loans where, for a certain period, you only pay the interest on the loan. This can keep your initial repayments lower, although you won’t be reducing the principal amount during this period. After the interest-only period ends, the loan reverts to a standard principal and interest payment structure.
To get started, you’ll need to apply for pre-approval from a lender by submitting necessary documentation like proof of income, employment details, and information about your current financial obligations. This pre-approval will give you a better idea of how much you can afford and allow you to search for properties within your budget.
How much deposit is required for an investment property?
As mentioned, when purchasing an investment property, you generally need to prepare a deposit that is at least 20% of the property’s purchase price, helping you avoid paying LMI. It’s important to note that some lenders may allow buying an investment property with a smaller deposit, such as 10%; however, this typically requires you to pay LMI.
The exact deposit you’ll need may vary based on the lender’s requirements and the loan-to-value ratio (LVR) – the ratio of a loan to the value of the investment property you’re considering – the lender is willing to offer you. If you already own property, you might also consider using the equity in your existing home as part of your deposit.
How much money can I borrow to buy an investment property?
Typically, you can borrow up to 80% of the property’s value without needing LMI. This means you’ll need to provide at least a 20% deposit to avoid additional insurance costs. However, some lenders may offer loan programs allowing you to borrow more than 80%, though this will incur LMI, adding to the overall cost of your loan.
To determine your specific borrowing capacity, lenders will assess your financial situation, including your net income, monthly expenses, existing debts, and any other financial commitments. They will also consider the expected rental income from the investment property, which can enhance your borrowing power. It’s crucial to have detailed and accurate financial records and a realistic estimation of potential rental income to present a strong case to lenders.
Furthermore, it’s important to factor in the costs associated with buying an investment property, including stamp duty, legal fees, property management fees, and maintenance costs. These expenses can affect your cash flow and, consequently, the amount a lender is willing to provide. Before applying for a loan, it is recommended to consult with a financial advisor or mortgage broker who can help you understand your options and obtain the best possible loan terms based on your circumstances.
Should you borrow money to invest in property?
Borrowing money to invest in property, commonly known as “gearing” or leveraging, can be an effective way for real estate investors to expand their investment portfolio and potentially increase their returns over time. However, it’s essential to be aware of the risks that come with investment loans. When you borrow for investment properties, you are increasing your potential for higher returns when the market is favourable, but you also increase the potential for significant losses if your property value declines or if you face rental vacancies. Your ability to service the loan is crucial, especially during periods when you are unable to collect rent.
Before deciding to borrow for an investment property, carefully consider your financial stability and long-term investment goals. Evaluate whether you can comfortably manage loan repayments along with your other financial commitments, even in less favourable market conditions. It’s advisable to have a solid financial buffer and consult with a financial advisor to assess if a property investment suits you given your financial situation and risk tolerance.
Are investment home loan rates higher?
Yes, investment home loan rates are typically higher than those for conventional mortgages. This is because lenders offset the higher risk of investment properties compared to residential real estate that borrowers intend to use as their primary residence. This higher risk is due to factors like potential vacancies on rental properties and the variability of rental income, which can affect your ability to meet monthly payments consistently.
When you’re considering an investment property loan, it’s important to factor in these higher rates, as they will affect your overall costs and the affordability of your investment.
What is the interest rate on investment property loans?
The interest rates on an investment property loan typically range from about 3% to 6%, which are generally higher than the rates for owner-occupied home loans, which range from approximately 2.5% to 5%.
The specific interest rate you qualify for on an investment property loan will depend on factors such as your credit score, the loan amount, the property’s location, and your lender’s specific terms and policies.
How to structure investment property loans?
When structuring an investment property loan, it’s essential to consider the loan type that best suits your financial strategy and goals. If you prefer stable, predictable payments, a fixed-rate loan could be advantageous, as it locks in your interest rate for a set period, protecting you against rate increases. However, if you anticipate that interest rates will drop or if you desire flexibility, a variable-rate loan might be preferable. This type of loan adjusts with market rates, which could potentially lower your payments.
Another strategic decision involves choosing between interest-only and principal-and-interest loans. As mentioned earlier, with an interest-only loan, only interest repayments are required initially to cover the interest while not reducing the principal balance. This can be beneficial for managing cash flow in the short term and is often eligible for tax deductions if the investment property is used for rental income. After the interest-only period ends, the loan reverts to standard principal-and-interest payments, which are higher by then. In contrast, principal-and-interest loans gradually reduce the loan balance from the beginning, increasing your equity but requiring higher initial outlays.
You might also want to consider utilising an offset account, which links to your investment loan. The cash reserves in this account offset the loan balance, reducing the interest calculated and helping you save on interest costs while keeping funds accessible.
Ultimately, your choice of loan structure should align with your goals, financial situation, and risk threshold in relation to buying an investment property.
Final Thoughts
Securing the right loan for your investment property purchase is about more than just accessing funds; it’s about strategically aligning those funds with your broader financial goals and the realities of the property market. Careful consideration of the amount to borrow, the terms of repayment, and the type of loan best suited to your needs will help ensure that your property investment is both profitable and sustainable.
Remember that making a smart investment decision begins with the right knowledge. So if you’re planning to buy an investment property, it’s crucial to stay informed and possibly seek advice tailored to your specific financial situation. Feel free to contact our financial advisors or expert mortgage brokers today, and we’ll be happy to guide you in securing your first investment property loan.
