Why do investors pay more for a home loan?

Investing in property has amazing benefits, from rental income and tax deductions to impressive capital gains. But even a casual browse of home loans reveals that investors tend to get saddled with higher interest rates than owner-occupiers. What gives?

Let’s explore why investors often pay more for mortgages in the long-run, and what they can do to manage the costs.

If you’re considering investing in a property rather than living in it, it’s important to compare how much an investment home loan could cost you long-term. 

While interest rates will vary between products, investment home loans tend to run higher overall. Even a difference of 5-40 basis points – as seen in the table below – can significantly accumulate mortgage costs over time. 

Fig. 1: Variable interest rates comparison for home loans worth $400,000 (27 September 2022, sourced from Mozo’s database)

Plugging these different variable interest rates into Mozo’s mortgage repayment calculator can give us a clearer idea of how investor loans can add up. For instance, assuming we want to borrow up to $400,000 over 25 years, different interest rates could cost the following:

Fig. 2: Average variable interest rates comparison for investors and owner occupied home loans worth $400,000

This gives us a mean difference of between $4,313 - 28,136 over the life of a loan.

While rental income could in theory help cover these higher costs, that’s assuming everything goes perfectly and you have a paying tenant for the entirety of your loan. Not to mention all the other fees involved, or the potential of a property market downturn or recession. 

So why do investors get slapped with a higher price tag?

When determining interest rates for home loan products, lenders consider a borrower’s risk profile and income serviceability. Anyone perceived to be high risk or financially unstable will usually have their borrowing capacity restricted and interest rates increased, to compensate for the liability.

Unfortunately, investors are seen as incredibly risky. Ironically, this is mostly due to property investment’s biggest perk: rental income. Rent-vesting or ‘flipping’ a property can be a major source of moolah, but rental income requires a lot of factors you can't control to go right, such as market conditions and rental occupancy. Plus, you're locking your assets into one big ticket item, which can make lenders more than a little skittish. And since you’re not living in the property, what’s stopping you from abandoning ship outright when repayments become too expensive?

While these scenarios might seem far-fetched or plain ridiculous, they’re very real threats to lenders. So they jack up interest rates accordingly. 

Investors also tend to have several investments running simultaneously, which means they borrow at higher levels of leverage and may have accrued other debts. Debt in general doesn’t look fantastic on a home loan application (even your HECS debt can haunt you), so it’s important to consolidate where you can.

Just to give you an idea of how risky investments look to lenders, between 2014-2018, the Australian Prudential Regulation Authority (APRA) specifically asked lenders to limit the amount of investor loans they gave out to reduce high-risk lending and improve practices.

There are a few things you can do to get a better deal on your investment home loan.

• Compare interest rates, since different lenders offer a wide range of interest rates (both fixed term and variable) for their home loan products. If you’re looking to maintain steady costs, fixed rate home loans could be the way to go, but you might miss out on savings if the lender cuts their variable interest rates later.

• Save for a bigger deposit, which decreases your application’s loan-to-value ratio (LVR). Owning more equity from the get-go lowers your perceived risk. 

• Have a good credit score. Reducing debts and showing that you can afford timely repayments will make your application deeply attractive to lenders. Read our guide to improving your credit score to get started.

• Liaise with a mortgage expert, since they can help you navigate the weeds and get a better deal.

• Research, research, research. Tracking changes in interest rates and comparing the best products on the market will give you a critical edge when looking for a home loan.

Looking to invest in real estate? Browse our investment property guides for more tips and tricks, or compare a selection of investor home loans below.