Not many people think twice about using credit to buy a new plasma TV, a new fridge or a car. But the idea of borrowing to invest somehow seems scary and risky.
The truth is that very few people have enough spare cash sitting around to pay upfront for an investment property. Borrowing to invest can give you the ‘leg up’ you need to afford an investment property that would otherwise be out of reach. To do so, you’ll usually need to take out a mortgage against that property or use the equity in your home to pay for it.
3 reasons to borrow to buy an investment property
• It’s possible to achieve higher gains and make more income, and so achieve your financial goals earlier
• Most costs (including interest) are tax-deductible so long as you keep evidence of expenses and can justify them
• You can afford to buy a better quality and wider range of properties than if you were restricted to using only your own capital
2 reasons not to borrow to buy an investment property
• You have to be able to afford the interest (especially if interest rates go up) payments and you will have to eventually repay the loan.
• If the value of your investment property heads in the wrong direction, you can end up losing money and you’ll still have to repay the loan – a negative equity situation.
Nevertheless, a properly managed investment loan can be a great strategy for growing your wealth faster.
Securing a great investment property loan
A mortgage is a mortgage, and most of the loans that can be used to purchase your own home can also be used to purchase an investment property. They’re re-labelled as “investment” loans, and the borrowing process and some of the loan features and conditions differ slightly.
You can borrow to buy an investment property in two main ways.
1. Using your own home as equity
The first is to use your own home as equity (if you own it outright or have paid off a lot of your mortgage already). This can involve redrawing on your existing mortgage or going back to the lender and increasing the loan amount to cover the new property. Some lenders won’t require a deposit for the investment property if you already have adequate equity in your home.
2. Using the investment property as equity
The second way to pay for an investment property is to use that property as equity, instead of your home. Most investment property loans allow you to make interest-only or principal-and-interest repayments. The best variable rates currently available are as low as 6.23% (fromUBank).
Right now, fixed rates on investment property loans are even lower. Homestar is offering 5.95% fixed for three years on its Investment Advantage loan. Deals like this, combined with low property prices, represent excellent value for long-term investors.
Finding the lowest available interest rate is as important when you’re borrowing to invest as when you’re borrowing to pay for your own home, but here are some other attributes that don’t apply much to a home loan yet are vital for an investment property:
• Portability. You might want to buy and sell investment properties more quickly than you would your own home, so having a portable, flexible loan is critical
• Low fees. Pay close attention to entry fees and exit penalties, especially if your aim is to use leverage to buy more than one investment property. You don’t want to have to re-negotiate the whole loan contract and pay set-up costs each time to add a new property
• High loan-to-value ratio. Investment loans that don’t require a deposit at all are preferable (the lender will accept equity in your home in lieu of a deposit), and you want to avoid paying lenders’ mortgage insurance (LMI) if possible
• Repayment flexibility. This is also important. You may prefer interest-only payments, particularly in the early years of establishing your property portfolio.