Loans for investing are used by purchasers of an investment property if they cannot afford to buy the property without loan finance. An investment property is usually purchased with the intention of renting the property to someone else, to create rental income and/or to realise a capital gain on selling the property, relying on property price increases over time.
More demanding loan conditions
Investment property home loans are subject to conditions which are different from the conditions on loans offered to owner-occupiers. Loans for property investors typically need a higher credit score and better overall creditworthiness than owner-occupier home loans. You can check your credit score here, free of charge, as often as you like. You can also get a free copy of your credit report – your credit history on which the score is based – once a year from the major Australian credit reporting agencies.
Since lenders need to be convinced that the investment borrower will be able to continue making the required loan repayments even if interest rates go up, they will also usually require a higher loan-to-valuation ratio (LVR). As a result, a higher deposit than the standard amount may be required.
Interest rates charged will also typically be higher than those offered to owner-occupiers.
Interest rates on loans for investment properties
Although the interest rates may be higher, investment loan rate types on offer will be similar to the rate types available for purchasers intending to occupy the property themselves.
Investment loan rates usually available are:
- Fixed interest rate, often reverting to a variable rate after an initial period of 1-5 years
- Variable interest rate, possibly featuring an extra repayment and redraw facility, and an offset account
- Split interest rate, meaning that a part of the loan principal is subject to a fixed rate, and the remainder to a variable rate
- Interest-only loan, particularly attractive to investors, because monthly payments are not repaying any part of the loan principal and are therefore 100% tax deductible. However, interest-only loans are riskier, particularly for the borrower, because they could result in negative equity (owing the lender more than the property is worth) in a property market where prices are falling.
Fees and charges for property investment loans
When investing in property, you also need to budget for the same loan fees that face owner-occupiers. Depending on the lender's fee structure, the percentage deposit you have saved and the loan term, you may have to pay any or all of the following fees:
- Application fee or loan establishment fee
- Lenders Mortgage Insurance (LMI) if your deposit is less than 20% of the value of the property
- Account-keeping fees payable monthly or yearly
- Early exit fee if you need to pay out the loan before the end of the agreed term
- Loan discharge fee when the agreed loan term comes to an end
- Refinancing fee if you need to refinance a short-term loan
Negative or positive gearing
When you deduct the cost of owning and maintaining a rental property (including loan interest charges) from the rental income you receive, you may make a profit. This is called positive gearing, and you will need to pay tax on the net income.
However, if the net result is a loss, this is called negative gearing. The annual loss you make on your investment property can be offset against your other income, such as your employment salary, to reduce the overall amount of tax you pay. Many investors are happy to negatively gear their investment property purchase because they expect to make a capital gain from property price increases, and the tax offset significantly reduces their holding costs.
Investors expecting to take advantage of negative gearing should always get advice from a tax accountant before taking out an investment loan.