If you are looking for a tangible, comparatively secure long term investment, property is probably a very tempting proposition. Like any market, property prices fluctuate from year to year, but if you zoom out over a long enough time period, properties tend to gain value over time.
Unless you have a six or seven figure sum sitting in your savings account though, it's likely that a home loan is a prerequisite for you to enter the investment property game.
Before you dive in and apply for an investment property loan, you'll want to assess your options. Infochoice has gathered an extensive selection of investment home loan products on the market, allowing you to compare interest rates, features, fees among other things to find the loan most suitable for you.
How are investor home loans different to owner occupied loans?
Lenders generally see investment loans as a riskier prospect, since people are probably more likely to default on mortgage repayments on a property they do not live in themselves. Because of this, investors tend to find there's generally higher interest rates, stricter lending requirements and lower borrowing limits.
As with any home loan, you'll need to show your lender you can afford your repayments without any problems. They will take into account both your sources of income and expenses. When it comes to measuring your living costs, lenders may use the Household Expenditure Measure (HEM) instead of your declared expenses.
How to increase your chances of home loan approval
There are several ways you can increase your chances of approval.
Have a good deposit or equity
Firstly, having a larger deposit decreases your loan to value ratio (LVR), making you a less risky proposition for your lender. Increasing your deposit size can also mean you avoid paying Lenders Mortgage Insurance (LMI), which normally applies to loans with an LVR over 80% (a 20% deposit size).
Additionally, if you have another home, you can usually use the equity in that as security, provided it's at least 20%. This is called leverage, and is what makes property an attractive investment for many.
Clear or minimise your other debts
Secondly, your lender will take into account any outstanding debts you have when calculating your expenses. If you have a personal loan or credit card debt to pay off, it could be a good idea to work to pay that off before you apply for a home loan. Improving your credit score is another way you can demonstrate trustworthiness to your lender.
In a similar fashion, lenders will likely take into account your full credit limit - not just your balance - so to increase your borrowing power, look to decrease your credit card limit.
Pick a suitable property
Finally, some lenders will be more cautious about investment home loans for certain types of property. It helps to think of an investment home loan like a business loan. Often, your ability to repay the full loan amount will be determined by how much money you are generating from your investment (how much rental income your property is earning or has the potential to earn).
In some instances, if you are buying a smaller apartment in an area saturated by similar rentals for example, lenders might feel that you will not be able to generate sufficient rental income from your investment, and be more reluctant to grant the loan.
Advantages of investing in property
1. Tax benefits
As an investment property is a source of income rather than a residence, much of the money you spend on it can be claimed back on tax. For example, you may be able to claim home and contents insurance on tax, well as maintenance and property management fees among other things. Fixtures and fittings, and the structure itself can be deductible.
If the costs of maintaining your property outweigh the rental income, this is called negative gearing. This amount can be deducted from your taxable income. If you want to find out more about tax benefits, it's advisable you talk to an accountant or property adviser.
One of the main attractions to property investment is leverage. If you are an owner occupier with at least 20% equity, this is usually sufficient to use as security for an investment property loan. While past performance is not a reliable indicator of future performance, anyone who's been in the property game for at least a few years likely has this amount of equity.
For example, if you've got 40% equity in a $500,000 home, that's $200,000, which is a 20% deposit on a $1 million property. And just like that you have a $1.5 million portfolio.
Leverage makes it easier to add to your property portfolio, and keep the chain moving. However you'd now also be paying two mortgages. As you leverage, you also heighten your exposure and risk of losses due to downturns. However, this is generally not as risky as leveraging shares such as through contracts for difference (CFDs) and margin loans, which are highly risky.
3. Capital gains
While the property market may take hits year by year, in the long term, property prices generally trend upwards. Holding on to an investment property for a number of years should hopefully see you make significant capital gains as the value increases.
When considering capital gains, you should also take into account the inevitability of inflation. While it's true that property prices almost always increase over a long enough time period, if the value of your investment property has not increased at the same rate as inflation, you will make a loss in real terms. For example, lets say someone bought a property for $500,000 in 2000, and sold it for $600,000 in 2010. While this has increased in market value, using the RBA's inflation calculator, we can see that $500,000 in 2000 is roughly equivalent to $672,263.03 in 2010, so they would have made a loss in real terms.
4. Rental income
Rental properties can mean a substantial second income, with some places in Australia currently generating an annual yield in excess of 5% of the property value. The decision on how to gear - positively or negatively - is up to you.
5. Insurance protections
Unlike many investments, the majority of events potentially damaging to your asset are insurable. Landlord insurance usually provides comprehensive cover against most of the common ways property is damaged, including flooding and other significant weather events, vandalism and impact damage from vehicles or trees.
Insurance can also cover your legal costs if someone is injured in your home i.e. liability cover. Landlord insurance is unique in that you can be covered from damages incurred by insect and other pest damage, as well as loss of rental income from damages that mean your tenants cannot live in the property.
Disadvantages of investment properties
1. The outlays
Buying a property is expensive enough, but you'll still need to pay for all the other expenses that come with owning a property even if you aren't living there. These are things like insurances, stamp duty, fire safety inspections, pest inspections and legal fees. You'll also have ongoing repair and maintenance costs.
Maintenance costs can be tax deductible, but you'll still need to pay for them upfront and won't see the benefits until tax time.
2. Risk of down periods
Any period of time you have no tenants in your rental property can eat into your profits. It's important to have contingency funds and a plan in place for if this happens.
Further, property downturns can and do happen - capital gains aren't guaranteed.
3. Liquidity and buying/selling hurdles
Most other forms of investment are easier to convert to cash than property. If you own shares for example, you can normally use investment apps or stockbrokers to sell your shares very quickly.
Selling a property on the other hand takes both time and resources. It can take months to find a buyer and sign the settlement contract, and that's before the settlement period where you might need to wait on the buyer to be approved for finance, as well as conduct building or pest inspections. If you are using an agency to sell your property, these costs can also be significant.
What to consider when comparing investment property home loans
Minimising the interest you are paying on your home loan can be one of the most important ways to maximise profits on an investment property. You'll need to consider whether you would prefer to fix your home loan rates and the length of your mortgage term as well as the interest rate itself. Interest payments can also be tax deductible.
Some home loans will allow you to temporarily switch to an interest-only (IO) loan for a set period. You might apply for an IO loan initially or switch an existing loan to interest only at some stage over the loan term.
Interest-only periods are generally longer for investors than they are owner occupiers. Many lenders allow 5 or 10 years' IO, extendable for another 5 or 10.
During an interest only period, you do not repay any of the borrowed amount you owe (principal), just pay the interest you are incurring. This can be a good way to navigate your home loan through a period where you temporarily have less money available (if you are also paying off a loan to make renovations on the property, for example).
However, once the interest only period is up, your principal repayments are likely to be higher as they are condensed into a shorter timeframe.
It is however entirely possible to opt for a say, five year interest-only loan, and sell the property after that five years is up. This minimises your mortgage payments in that time, and hopefully the capital gains do the heavy lifting to repay the principal while you make profits from the rent.
It's helpful to think of an investment property home loan as a business loan. You should be aiming to maximise your profits and tax benefits across the loan term. You might want to take the time to work out your projected income and expenditure over a certain time period, taking into account anything you can claim on tax.
Additional fees and costs
As with most loans, interest payments on an investment home loan are rarely the only costs on top of the loan amount. Loans may have application fees, annual servicing fees or penalties for extra repayments, among others. Keep in mind though that often high fees will mean reduced interest rates.
Over a typical 30 year home loan term, it can be worth copping a few hundred dollars in annual fees for a significantly reduced interest rate. A good way to accurately get a sense of your real out of pocket expenses is to check the comparison rate as well as the interest rate, as this is indicative of any additional fees that may apply.
There are several features offered by some home loan providers that can be very useful over a loan term. An offset account can be a great way to reduce the interest you pay while still retaining access to your additional funds should the need arise. Alternatively, a redraw facility also allows you to make overpayments whilst still having the option to take your money back out again.
If you anticipate regularly being able to pay more than your scheduled monthly repayments, it is probably a good idea to prioritise these extra features which could save you many thousands of dollars. Keep in mind that offset accounts likely attract fees or an interest rate premium.
How to maximise your investment property's potential
There are several strategies investors use to get the most out of their rental property
1. Negative gearing and tax benefits
Negative gearing refers to any situation, not just property, where the expenses associated with an asset (including interest payments) are higher than the income it generates. An investment property is negatively geared if the aggregate of interest payments and maintenance costs is higher than the rental income. This is particularly common in the first few years of an investment property, where you might be spending more money repairing or renovating.
While negative gearing intuitively sounds like something to be avoided, these losses can be offset by deducting them from your taxable income. Negative gearing can be particularly useful if you anticipate a large capital gain return on your property. If you have owned a property for more than 12 months, only 50% of the gain in value is taxable when it is eventually sold.
If you buy a property with a modest expected rental yield, but big potential for capital gains growth, you can use the tax benefits of negative gearing to offset your early losses, let the value of your property shoot up and then profit once you sell it.
Buying a more modest or disheveled property and fixing it up is often cheaper than buying a house that's already perfect. Renovations should mean your rental income increases, as well as the value of the property. A popular strategy is to invest in development early on, negatively gearing your property for the first few years and offsetting your losses with this method.
3. Doing your research
While no one can truly predict the property market, there are several indicators of future performance that you should consider before choosing your investment property.
You should look into the suburb that the property is in; go through average rental yield, past performance and any future investment to get a sense of how the suburb will perform in the next few years.
You should also review the sales history for the property, as well as vigorously assess the condition it is in. A helpful way to help with this is to use Infochoice's free property report. You just enter the address of the property to get a comprehensive report on both the property and suburb. You'll be able to see an estimated value, sales and rental history and similar properties listed in the surrounding areas.
The information contained on this web site is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser. If you or someone you know is in financial stress, contact the National Debt Helpline on 1800 007 007.
Comparison rate is based on a secured loan of $150,000 over the term of 25 years.
WARNING: These comparison rates apply only to the example or examples given. Different amounts and terms will result in different comparison rates. Costs such as redraw fees or early repayment fees, and costs savings such as fee waivers, are not included in the comparison rate but may influence the cost of the loan