What is an investment loan?
An investment loan is a mortgage that someone takes out to buy an investment property. It differs from a standard mortgage in that there are stricter eligibility requirements, a larger deposit is required and the interest rate is higher than an owner occupier home loan.
Lenders charge more for investment loans because investors are considered a higher risk of defaulting on a loan than owner occupiers, who are not borrowing to make money but to put a roof over their heads.
Types of property investment
When you invest in property, you would probably adopt one or more of the following strategies to try and make a profit from your investment;
- Buy and hold - buying a property and holding onto it, hoping that it will increase in value over time and you can eventually sell at a profit.
- Negative gearing - if the expenses on the property are more than the income it generates through rent, you can claim the loss as a tax deduction. This is a strategy used by many investors to cover their early losses while waiting for a property to grow in value.
- Renovating – buying a fixer-upper, renovating it yourself, raising the property's value and then selling at a profit. This is a popular investment strategy with young couples who have some DIY skills.
- Passive development – investing in a project by putting up the money for a property developer to develop the project to completion and then making a profit when it sells.
Types of investment loans
Just as there are different investment strategies, there are also different types of investment loans including;
- No-frills loan - basic mortgage with minimal features but lower interest rates and fees.
- Package loan - a variable, fixed or split rate loan bundled with other products such as transaction accounts and credit cards.
- SMSF loan – a home loan purchased through your self-managed super fund.
- Low doc loan - a higher interest loan for self-employed people with limited proof of income.
- Bad credit loan - a higher interest loan for investors with less than perfect credit scores.
- Line of credit loan – a revolving line of credit which uses the equity in your home to finance an investment property.
- Bridging loan – a short-term loan used to purchase a property before an existing property is sold.
- Construction loan – a loan that provides access to funds at various stages of construction when required by the builder.
- Interest only loan – a loan where you only pay off the interest in order to free up your money for other investments.
Who can buy an investment property?
You don’t have to be a citizen to buy investment property in Australia. Non-residents and residents can invest in new buildings and vacant land, but they cannot invest in established dwellings. Only Australian citizens can buy either established or new dwellings for investment purposes.
To be eligible for a property investment loan, you must have at least 5% in genuine savings (held in an account for at least 3 months), equity in other properties (particularly if you are borrowing more than 90%), stable employment and a good credit history.
How much can you borrow?
Most lenders will only lend a maximum of 95% of the property’s value, unless you have a guarantor such as a parent, in which case you can often borrow 100% or 105% of the value.
If you borrow more than 80% of the value, you will be required to pay Lenders Mortgage Insurance (LMI) to cover the lender if you default on the loan, so this will have to be budgeted for as well as the various costs associated with buying a property (LMI can be up to $10,000).
So as long as you have 5% in genuine savings for the deposit and another 5% or so to cover LMI and purchasing costs, you should be in a position to be able to buy an investment property.
What sort of property should you invest in?
When looking for a property to invest in, you will need to consider factors such as whether it is in an area of growth (i.e. have values grown or fallen in recent years?), whether there are plenty of employment opportunities (as opposed to reliance on one main employer or industry) and whether there is good infrastructure including schools, shopping centres, hospitals and public transport.
A lender might consider a property worth funding if it is a unit, townhouse or house in good condition, with a living area larger than 50m² and situated in a high demand location such as a major town or city.
How do you compare property investment loans?
When looking for the right property investment loan, you need to compare loans keeping the following factors in mind;
- Interest rates – look for a low interest rate and compare fixed and variable rates to find one that suits your investment strategy.
- Features & benefits – look for a loan that doesn’t penalise you for making extra repayments and offers features such as an offset account and redraw facility.
- Fees - compare application, valuation, exit and legal fees and also ongoing monthly and annual administration fees.
Pros and cons of property investment
When deciding if property investment is the right choice for you, be sure to keep the following potential advantages and drawbacks in mind;
- Rental income - a well located investment property can provide up to 5% in rental yield.
- Capital gain – you can make a significant profit if you sell after the property has increased in value.
- Tax benefits - property expenses can be subject to attractive tax deductions on things like interest rates, maintenance, depreciation and insurance.
- Negative gearing – this can help you offset any initial losses until your property gains in value.
- Greater security & control – property investment offers you more control over your asset than investing in shares or other more volatile asset classes.
- Rising interest rates – these can make your repayments more difficult or if they continue to rise, even unaffordable
- Property depreciation – if the market in general or a particular region experiences a slump, it may take much longer to realise a profit.
- Rental shortfall – inability to rent or damage or default by tenants can mean significant losses.
- Overcapitalisation – spending too much on improving the property for sale or rent can result in a negative return on investment.
- Slow realisation – buying and selling property takes a lot longer than shares, meaning you may not be able to access your money quickly if you need to.
Compare investment loans
Property investment is a significant step and it is a good idea to seek professional advice before committing yourself to a loan. A mortgage broker will listen to your requirements, offer valuable advice and use their significant resources to compare loans from a variety of lenders to find the one best suited to your needs. And it’s a service that won’t cost you a cent!
Compare today's lowest investment loan rates & repayments from 30+ banks and specialty lenders and talk to us soon at Loan Market.