Who can resist the allure of the buzzing property market? Your property is likely to appreciate in value, plus if you get a tenant in the rent could cover your ongoing repayments and other associated property costs.
Even if your property is negatively geared, when it comes to tax time you can deduct the amount you’ve lost on your property to bring down your taxable income. Sounds awesome right?
While investing in property has its many perks, there are some things you’ll need to keep in mind when looking for investment home loans to ensure you pick the right loan for you.
The first thing you should think about is your...
Loan to value ratio (LVR)
The Australian Prudential Regulation Authority has been putting pressure on banks to reduce their investment loans book to under a 10% growth per annum.
As a result major banks are beginning to put caps on the amount that investors can borrow and are generally implementing new eligibility which requires investors to have a loan to value ratio of 80% or less.
If more lenders in Australia follow suit and you’re a first timer wanting to purchase your first investment property you will either need to wait until you have saved up a 20% deposit (e.g 80% LVR) or ask your parents to be your home loan guarantor, which means they will put up a portion of their own home as security for your investment loan to help you get approved.
Another thing to keep in mind is big banks have also increased their stress tests, which means when they assess you for an investment property loan they will see if you can comfortably service the loan at a higher interest rate. For instance, if their standard variable interest rate is 5%, they may use a 7.5% scenario to see if your income could easily manage a rate rise in the future. Get an idea of how much you
could afford to repay if rates were to climb, by using our rate change calculator.
Choosing the right investment home loan
Once you know you fulfill the requirements when it comes to the amount you’re looking to borrow, it’s time to think about the type of investment property loan you’ll sign up with. One of the more popular options is choosing an interest only home loan. Read on for a full definition:
Interest only home loans
As the name suggests, unlike a standard home loan where you repay both the principal and the interest, with an interest only investment loan you’ll only repay the interest. This means that your ongoing repayments will be significantly lower.
Check out this scenario: Sarah wants to borrow a total of $500,000 paid back over 25 years. Our home loan repayments calculator shows with a 5% interest rate, if she chose the principal and interest repayment option her monthly repayments would be $2,923. But if she opted for the interest only option for the first 5 years, during this period her ongoing payments would be brought down to $2,083.
Another reason interest only home loans are a popular option for investors is because of a little something called negative gearing, which means if the cost of repayments and looking after the property is more than your returns in rent, you can claim the home loan interest andproperty maintenance come tax time and potentially get a partial to substantial refund on that amount.
While the interest only period won’t last forever (generally for 5 years) and you’ll eventually have to start paying off both the interest and principal, you could negotiate at the end of the interest only period to have it extended for another 3-5 years.
But keep in mind, interest only home loans aren’t for everyone. The whole point of an interest only loan is you’re relying on your property’s value to increase over time. This can be risky if you’re buying in an area that could see a drop in property prices down the track, so in this instance you may be better off paying down both the
principal and interest.
Variable, fixed or split interest rate?
Whether you choose an interest only investment loan or the standard principal and interest repayments, you’ll be able to choose the type of interest rate to suit you.
- Variable interest rate: The more popular option in Australia is the variable rate option, which changes according to the economy. The reason many investors opt for variable rate home loans is because they generally come with greater flexibility than fixed rate loans like an 100% offset account (see below for a full definition), which allows you to bring down the amount of interest you pay.
- Fixed interest rate: By comparison, a fixed interest rate will mean your rate is locked in for the fixed rate period. While more and more providers are introducing fixed rate loans with an extra repayments facility (with a cap of around $10,000 per annum), fixed rate loans generally don’t come with an offset account.
- Split interest rate: You could also consider splitting your investment loan, which means a portion will be variable allowing you to enjoy the benefits of an offset account on the variable amount and the remainder will be fixed giving you some security if your lender lifts rates.