Real estate is considered a great investment option because of the potential benefits the market can provide. It is often viewed as a secure investment that is less likely to be impacted by market shifts and more likely to yield fixed returns even in the current economic climate. You can also use your real estate investment as a rental property with the goal of generating a steady flow of passive income.
But just like buying your own home, property investments require heavy financing. And if you are among those investors who do not have a huge bankroll, taking out an investment home loan may be the only way to seal the deal.
So, how different is an investment loan from a regular home loan? What are the things you need to consider when taking out a loan for an investment property? This guide will give you the answers.
What is the difference between an investment home loan and a standard home loan?
An investment home loan is designed for borrowers who are looking to purchase or renovate a property with the goal of making a return from it in the future. On the other hand, standard home loans, also known as owner-occupier home loans, cater to borrowers who plan on living on the property they intend to buy.
Compared to regular home loans, investment loans usually come with higher interest rates and have stricter eligibility requirements because lenders often see investors as risky borrowers. The reason is that, unlike owner-occupiers who may feel an emotional attachment to their homes, many lenders believe that investors are more inclined to take financial risks to maximise returns on their investments – which may cause them to default on their mortgage.
Are you eligible for an investment home loan?
Just like when applying for other types of home loans, lenders conduct background checks to make sure that you are in a secure financial position to meet monthly repayments. But because of the perceived higher risks associated with investors, the eligibility requirements for investment loans are often more stringent. Here are some of the criteria you need to meet:
1. Stable employment
Lenders check your annual income based on your pay slips and most recent tax statements to find out if you are gainfully employed. Some lenders may also use the following criteria to determine if your employment situation makes you a decent candidate for an investment loan:
- Must be working for the same company for at least two years
- If you have moved on from one job to another, the new job must be in line with the previous position
- If you made a career switch, you must be in the job for at least six months to a year
- Must not have more than three employers over the course of two years
- Must not have significant breaks in employment
- Must not be on probation at your current job
- If self-employed, you are required to show proof of tax returns for the past two financial years
2. Genuine savings
Most lenders want to confirm if you have genuine savings equivalent to at least 5% to 10% of the property’s value. They will also check if you have resources allotted for the deposit that are separate from your genuine savings.
3. Good credit history
Having a good credit history and an above-average credit score can improve the chances of getting approved for your loan. Find out the important things you need to understand about your credit rating and how it affects your ability to get a home loan by visiting this page.
4. Built up equity
If this is not your first time applying for an investment loan, some lenders will check to see equity you have built up on your other properties – especially if you are borrowing more than 90% of the property’s value.
How much can property investors borrow?
Banks and other financial institutions often lend no more than 80% of the value of a residential property and up to 70% for a commercial property. But there are cases when lenders are willing to grant loans as much as 95% or even 100% of the property’s value.
For loans exceeding the standard 80% for residential and 70% for commercial, you will need to pay lender’s mortgage insurance (LMI). Our LMI estimator can help you calculate the amount you need to shell out for this one-time fee designed to protect lenders from financial loss.
If you want to know if how much an investment property will cost so you can determine if you can afford the monthly repayments, this investment property calculator can help provide an estimate.
What features should you look for in an investment loan?
When shopping for the right investment home loan, experts recommend looking beyond interest rates and checking if the loan contains features that fit your financial situation. Loan features are designed to help you in a variety of ways – including managing your finances and reducing the length of your mortgage. The best features, however, are those that allow you to significantly cut the cost of the loan, helping you save thousands of dollars down the line.
Here are some of the features you should be looking for in an investment loan:
1. Interest-only payments
An interest-only home loan allows you to pay only the interest for a certain period. The typical length is five years, but this can be extended depending on your agreement with your lender. The principal amount, meanwhile, stays the same for the duration of the loan term. This feature can significantly reduce your monthly repayments, allowing you to save cash that you can use to further grow your investment portfolio.
Additionally, if you are renting out your property, the Australian Taxation Office (ATO) says that you can claim the interest charged on the loan on your personal tax return. You can check out the many ways your rental property can minimise your annual tax bills by visiting this page.
2. Offset account
An offset account works like a savings account where you can stash your extra funds. It comes with a debit card that you can use to withdraw money and to pay for everyday expenses. The biggest advantage of having an offset account is that the balance reduces the amount of interest charged to your loan. To illustrate, if you have a $450,000 loan with a 2.75% interest rate and you put $30,000 on your offset account, the rate will only apply to $420,000 instead of the entire loan amount, saving you money in the process.
3. Line-of-credit facility
A line-of-credit facility allows you to access a predetermined amount of credit without applying for another loan. The amount you borrow is typically secured against the equity you have built in your property and can be used for a variety of purposes – including home renovations, lifestyle expenses, debt consolidation, or another investment property.
However, there are some drawbacks. Because line-of-credit facilities allow a relatively easy access to funds, loans with this feature often have higher interest rates. You also need to pay for the different fees and charges associated with accessing your property’s equity.
4. Repayment holiday
If you intend to cover the bulk of your mortgage repayments using your rental income, this feature can help you. A repayment holiday allows you to pause monthly repayments for a certain period, usually between a few months and a year. This can help you in instances when your rental property is left unoccupied and unable to give you a steady stream of income to pay for your monthly dues.
However, you must remember that interest charges continue to accrue while you are on a repayment lull. This means that at the end of your loan term, you will have paid more than you originally owed.
5. Ability to choose repayment frequency
Your investment loan should also give you the flexibility to choose repayment frequency. The reason is that experts recommend syncing your repayment schedule with how often you get rental payments from your tenants. If your tenants pay rent on a weekly basis, then your repayment for your home loan should also be on a weekly term. This will not do much in the short term, but it can add up and help you save on your loan down the line.
What are the best mortgages for property investors?
Home loans vary from lender to lender, and often the best way to determine which ones fit your needs and financial situation is by comparing interest rates, loan features, and mortgage repayment terms.
Fortunately, Your Mortgage gives you a comprehensive comparison of the best investment home loans available from Australia’s top lenders. Click here to view and compare.