Most people don’t know it, but the success of an investment property does not only depend on choosing the right property but also on the right investment property loan.

It’s understandable that most investors focus on property first when thinking about investing in real estate, but securing financing is the crucial first step before they can buy investment property.

But how do you choose the right loan?

In general, investment property loans are not much different from homeowner loans. But to have a successful real estate portfolio, you need to have a solid investment strategy in place to determine the type of loan that best suits your needs.

The type of loan you choose can also dramatically affect your cash flow. Therefore, investors should think about how they would repay the loan before choosing a financial product that suits their investment strategy.

With that said, let’s take a look at what loan options are available to real estate investors and how you can choose the one that fits your strategy.

Types of real estate investment loans

Here are the different types of loans that investors can choose from:

  • Principal and interest loans (PI)

This is the most common type of loan used by homeowners who want to pay off their mortgage as quickly as possible. In this type of loan, the repayment is made up of the interest rate and part of the principal so that you pay part of the original purchase price as well as the interest up front.

As the amount of principal decreases, the interest payable also decreases. Therefore, a larger portion of the repayment is applied back to principle in later years, gradually releasing borrowers from debt.

Interest-only loans are the most common type of financing used by real estate investors in Australia. This is because interest only loans can be used by investors to maximize their tax deductible expenses. Interest-only loans can be fixed or variable.

With an interest-only loan, your repayments will only cover the interest component of your loan for a specified period of time and will not reduce the amount of principal you owe. Because you are not paying off any debt on the property, you can keep your repayments to a minimum and this can also be claimed as a tax deduction.

Typically, interest-only loans are for a maximum term of five years (depending on your loan provider). At the end of the agreed term, you revert to a loan in principal and interest. But in some cases, another interest-only loan can be negotiated with your lender at the end of the term.

This type of loan is considered the best cash flow when combined with good capital growth. Assuming that the property’s value increases enough over time, an investor can eventually sell it and then use the money to pay off the principal while still making a profit.

However, there is always a risk with interest-only loans that the value of the investment property will not increase enough, which can burden you with significant debt.

Do you already own a property? If the answer is yes, then good news! You can use the equity in one property you own to secure a home loan for the next. The equity in your property can be used to fund the deposit on your investment home loan.

Most lenders allow you to borrow up to 80% of the equity in your home. You can borrow a lump sum against the equity in your home or choose to open a line of credit that acts like a credit card with a large credit limit while your property serves as collateral for your mortgage. The best part about this setup is that you will only pay the interest on the amount you withdraw from your line of credit.

Tips for finding the right investment real estate loan

Now that we have discussed the types of loans that you can access, here are some practical tips on how to choose the right one.

1. Do your research.

If you are new to the real estate scene, the terminology around investing and mortgage loans can be confusing and complicated.

It’s a good idea to put the brakes on before you even think about applying for a loan and learn all the concepts related to real estate investing such as negative debt, real estate cycles, tax breaks for real estate investors and amortization to help you better understand decision.

To help you get started, you can bookmark the Smart Property Investment Glossary of Terms – Search page for all real estate investing terms. You can also listen to our podcasts covering a wide range of topics that can help you become a smarter investor.

2. Make sure you have a solid investment strategy.

Once you’ve done your due diligence, now you need a plan. Your investment strategy will be a key factor in determining the type of investment loan you choose.

For those investors who are committed to the long term, they choose to follow the “buy and hold” strategy. For example, they can choose to buy a property and pay it off in full over time while still collecting the rent.

Meanwhile, other investors who are confident that their property will appreciate quickly may choose another type of loan.

If you already own a property that you fully own (or if you have paid off most of it), you can use its equity to finance the purchase of your investment property. This will increase your borrowing power and you won’t have to worry about saving for a big down payment.

Or you can take out a line of credit loan rather than a traditional investment real estate loan.

An investment strategy is only a key part of your financial plan. When you are considering making an investment of any kind, it is important to make sure that it is in line with the overall financial picture that you are plotting.

3. Establish a strategy for your repayments

To manage your finances well, you need to make sure that your payments are organized in the way that best suits your needs.

First, your repayment terms will depend heavily on your investment strategy.

For example, if you buy a property and you are sure it will increase in value quickly, you can make small interest-only repayments. This lowers your costs before your property is sold (ideally for a big profit).

Meanwhile, interest-only loans cost more in the long run, but that won’t be a problem if your property isn’t experiencing strong capital growth.

For risk-averse long-term investors planning to pay off their investments in full while receiving rent, a principal and interest loan will cost less in the long run. With this strategy, you can also build equity faster.

4. Choose the best interest rate

The interest rate on your investment loan is obviously an important factor. As a general rule, the lower the rate, the lower your repayments will be. Even a difference of 10 or 20 basis points can represent tens of thousands of dollars in repayments over the life of a loan.

You will also need to decide whether you want a fixed or variable interest rate. Variable rates can go up without warning, but they can go down too.

Fixed rate loans provide a period of certainty where you know exactly how much your repayments will be. While you are immune to rate hikes during the fixed period, the downside is that you will not benefit from spot rate cuts.

You can also cover your bets by splitting your loan, varying a certain percentage, and fixing the rest.

While interest rates are important, they shouldn’t be the deciding factor when choosing a loan. Plus, be sure to read the fine print for any hidden charges that can hurt your pockets in the long run.

5. Get a loan with the features you need

Last but not least, be sure to check out the features of a loan. Knowing the types of features offered by an investor loan can help you identify what will work best for you and get the most out of your investment.

One loan feature that is popular with investors is a clearing account. A compensatory account is a savings account linked to your credit. The money in the savings account (balance) is offset against the loan amount, thereby reducing the amount of interest you are charged. You can save a lot of money by reducing the compound interest through the use of these accounts.

One of the benefits of this option is that you can pay off your home loan faster than the repayment schedule requires while still being able to withdraw cash if the need arises.

However, the downside is that it is not available for all home loans. But when available, they usually come in the form of a linked transaction account or savings account.

Another important feature that is often overlooked not only by investors, but by home buyers in general, is the ability to choose the frequency of repayments.

For example, if you have a rental property, it is a good idea to synchronize your repayment schedule with how often you receive rent payments from your tenants. If your tenants pay their rent on a weekly basis, your mortgage repayment should also be weekly.

While this may not have a significant impact in the short term, it can add up and save you money on your home loan. For example, if your repayment schedule is bi-weekly, you can make an additional month of repayment, knowing that there are 26 fortnights per year, which equals 13 months.

Smart Property Investment provides Australian property investors with essential information, strategies and real-world experiences to help them make successful buying and selling decisions in the Australian property market. Tune in to our podcasts covering a variety of topics related to the real estate market. You can also follow Smart Property Investment on social networks: Facebook, Twitter and LinkedIn

RELATED TERMS

Investment property

Investment property refers to land, condominium or building purchased for profit through rentals or capital appreciation.

Mortgage

Mortgages are loans that are used to purchase homes and other real estate where the property itself serves as collateral for the loan.

Mortgage

Mortgages are loans that are used to purchase homes and other real estate where the property itself serves as collateral for the loan.

How to choose the right home investment loan in Australia



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Last updated: November 10, 2021

Posted: 23 September 2021