How does an investment property loan work?
An investment property loan is a crucial component of any property investment strategy. As it will most likely be the most significant expense, understanding what options are available, how the loan works, and what you can do with the funds can help you save money.
As investment property loans are a flexible cash instrument, knowing the ins and outs of this mortgage type also gives you the insight you need to manage this capital injection effectively.
Financing your investment property loan
When you approach a financial institution and apply for an investment property loan, you need to provide a deposit. Typically, this amount ranges between 5 per cent and 20 per cent of the property’s value.
Let’s use an example where the property value is $850,000. In that instance, you would need a deposit ranging between $42,500 and $170,000. In addition to the amount, you would also need to cover additional administrative expenses such as land tax and stamp duty.
Depending on the property value, coming up with the deposit and other costs could be a challenge, even if you have the income to cover the mortgage’s monthly payments. However, there are options available that could help you overcome these obstacles.
Lenders Mortgage Insurance
Typically, investment property loans are highly-leveraged. Depending on various financial circumstances, you may only need to provide between 5 per cent and 10 per cent of the property value as a deposit. However, if you choose to finance more than 80 per cent of the property’s value, the financial institution may insist on Lenders Mortgage Insurance (LMI). Although LMI may add to the monthly premium you need to pay, it is an option if you do not have the 20 per cent deposit amount required.
100 per cent investment property loans
If you do not want to part with any upfront cash when you purchase your investment property, there are options available. These alternatives give you the ability to finance up to 105 per cent of the property value. You could use a guarantor loan for investment or another property as security.
A guarantor loan gives you the capability to finance up to 105 per cent of your investment property’s value. It is your best option for getting started and uses the equity in another person’s property as security. Typically, this additional property belongs to a parent or close relative. There are several benefits to using this loan option. Firstly, guarantor loans have very competitive interest rates when compared to other alternatives. You do not have to pay any Lenders Mortgage Insurance, and as you can get up to 105 per cent of the property price, it can cover additional expenses such as land tax and stamp duty. The only caveat with this loan type is that you can only use it to purchase one investment property. Depending on the institution, your parents or close relative may also not need to guarantee 100 per cent of the loan’s value.
Using another property as security
Another financial option that can give you access to a 100 per cent property investment loan is using another property as security. If you already own property, you can use the equity in that asset to secure your investment loan’s deposit. Depending on the financial institution, you could get financing of up to 105 per cent of the property value. As with the guarantor loan, you can use the additional funds to cover administrative expenses.
If you do not have access to either a guarantor loan or another property you can use as security, the maximum property investment loan amount you will be able to obtain is 95 per cent of the property value.
Investment property loan features
Once you have secured access to your investment property loan, specific options are available that affect the monthly premiums payable. Depending on your financial circumstances, some options reduce your monthly payments while others decrease the loan’s term.
One of the core tenets of fiscal prudence is to ensure your revenue exceeds your expenses. This fundamental principle also extends to the cash flow portion of any financial transaction. Your payments should ideally only occur after you receive your income. With an investment property loan, negotiating your repayment frequency can shave time off your loan period. For example, you could set your repayments to occur fortnightly instead of monthly. As there are 26 fortnights in any given year, 26 payments equate to 13 monthly payments instead of the usual 12.
An offset for a property investment loan is effectively an extra bank account linked to your loan account. The financial institution deposits any payments that exceed your premiums into it. You can then withdraw these additional funds and use them to pay for your general expenses. However, an offset account also helps you save on interest charges. When calculating your interest payments, the financial institution deducts any funds in your offset account from the capital amount owed. Even though you do not earn interest in this arrangement, leveraging an offset account can reduce your monthly premiums.
Some investment property loans offer an interest-only feature for a set period, typically five to ten years. Using this facility significantly reduces your monthly premiums as you only pay the loan’s interest portion, not the capital amount. Even though the loan value remains static for the interest-only period, you can leverage this facility and use your funds in other ways. For example, you could use the extra cash to renovate the property and then sell it before the interest-only term ends.
In some instances, you may invest in a property where your monthly expenses exceed your rental income. This loss is known as negative gearing, and although it may sound like it is fiscally irresponsible, there are scenarios where this option works. The net loss you incur due to this arrangement is tax-deductible. That means you could end up with a positive outcome depending on your other tax liabilities, income, and expenses. You can also use this strategy with an offset account. As you gain extra funds, you can then slowly increase your contributions until your gearing changes. As there are so many variations that apply, you must get the property financing solution that works for you.
Loan serviceability factors
When applying for an investment property loan, the financial institution takes various factors into account before agreeing to a loan amount. These include your gross income, tax and medicare expenses, negative gearing benefits, existing commitments, and living expenses. The net outcome of these calculations determines your loan amount eligibility. As the financial institution needs to manage its risk, it will only grant financing that it is reasonably sure the investor can afford.
Get the right advice
With so many options and variations, choosing the right investment property loan can be overwhelming. Talking to an expert that specialises in these transactions can help you make the right decision that fits your investment profile.
At HERE Properties, our finance team can help you get the property finance solution for your investment. Get in touch with us, and let us get you the right loan at the right rate.