The facts every property investor should know about investment loans

Rising property prices and the complexities of securing a loan often make property ownership feel out of reach.

However, alternatives like rentvesting offer first-time buyers a way into the property market by allowing them to rent where they want to live while investing in a more affordable area, providing a practical solution to the challenges of property ownership.

Investment property loans, unlike owner-occupied home loans, are specifically designed for buying properties aimed at generating rental income.

Loans for investors typically come with higher interest rates because investment properties carry more risk for lenders, particularly if the borrower relies on rental income to cover loan repayments.

Therefore, these loans generally come with different terms and stricter lending criteria than mortgages, such as larger deposits, stronger credit scores, and assessments of borrowing capacity factoring in other existing debt.

Types of investment property loans in Australia

There are generally three common types of home loans available, each primarily defined by the structure of the interest rate applied to repayments.

Fixed rate loans

A fixed rate loan locks in the investor’s interest rate for a set period. This offers stability in repayments, shielding the investor from interest rate fluctuations, but they may miss out on any decreases in interest rates.

Variable rate loans

With a variable rate loan, your interest rate can change based on the market. While this offers flexibility and the potential for lower repayments if rates drop, it also carries the risk of increased repayments if rates rise.

Split loans

A split loan offers the best of both worlds, combining elements of both fixed and variable rates. A portion of the loan has a fixed rate, while the remainder is variable, allowing the investor to balance stability and flexibility.

Terms of repayment on property loan

There are two terms of repayment on which loans can be taken: principal and interest or interest-only. Each term impacts how an investor manages cash flow and debt repayment over the loan period.

Principal and interest loans

With a principal and interest loan, an investor repays both the borrowed amount (principal) and the interest charged over the term. This is a more conservative approach to borrowing, as it ensures that the investor is steadily reducing their debt over time.

Interest-only loans

Interest-only loans allow investors to pay just the interest on the loan for a set period. This results in lower monthly repayments, freeing up cash flow. However, at the end of the interest-only period, repayments will increase as the investor will begin repaying the principal as well.

Interest rates vary between lenders and loan types, and even a slight difference can significantly impact investment returns. Comparing both fixed and variable rates will help an investor choose the option that aligns best with their investment goals.

When considering repayment terms, the investor will need to balance cash flow with long-term equity building. Interest-only loans, for instance, provide lower monthly repayments, which may improve short-term cash flow but won’t reduce the investor’s debt principal.

Loan servicing ratio, additional expenses

Investors should assess their own loan servicing ratio (LSR) considering rental income, personal income, and ongoing expenses like maintenance and taxes. A strong LSR is crucial for qualifying for larger loans.

Many loans come with features such as offset accounts, which are savings or transaction accounts linked to the home loan and redraw facilities that allow access to extra repayments or help reduce interest.

Refinancing an investment loan when market conditions shift can secure better terms or adjust the loan to meet evolving financial goals and is generally most beneficial for those who had a deposit of at least 20 per cent when securing a loan.

If the investor’s equity is below 20 per cent, they may need to pay lenders mortgage insurance (LMI) again when refinancing, or they might not qualify. If the investor is thinking about refinancing, getting a property revalued could help lower the loan-to-value ratio (LVR), potentially reducing the interest rate.

In addition to choosing the right loan type, repayment terms and interest rate options, investors should also consider property depreciation as a critical element in their investment strategy. Depreciation allows property investors to claim tax deductions on the wear and tear of the building and its plant and equipment assets over time, effectively lowering the investor’s taxable income, enhancing cash flow.

By leveraging both loan structures and depreciation schedules, investors can optimise their financial outcomes and mitigate some of the costs associated with investment property ownership.