Mortgages for investors
Many people borrow money to buy investment properties, aiming to benefit from rising property values or to earn rental income.
If this is in your plans, you'll want to shop around to compare fees, interest rates and services just as you would if the loan was for your own home. But there are some additional things you'll need to consider which can have a big impact on your investment returns.
In this section you'll find information about:
- Lending criteria for investment loans
- Tax deductibility of the loan interest
- How borrowing affects your investments returns and risk
- Whether and when to repay the loan
Lending criteria for investment loans
Many lenders provide loans for residential property investments at the same interest rates and fees as their ordinary home loans. Some lenders will even lend to 95 percent of the property value. But a few lenders have lower lending limits for investors, or will lend a lower proportion of the property value if you're buying an apartment, or a residential property outside the urban areas. This just reflects the higher risk lenders are taking.
As with ordinary home loans, lenders will look at what you can afford to repay. For example, a lender might prefer that the interest on the loan should not be more than 75 percent of the gross rental income and 35 percent of your gross personal income.
You can also expect to pay a 'low equity premium' or 'mortgage indemnity insurance' fee if you borrow over 80 or 90 percent of a property's value.
Tax deductibility
One of the key differences between a loan for your own home and for an investment property is that the interest on a loan taken out for investment purposes is tax deductible. It doesn't matter whether the property used as security for the loan is your own home or one you rent out - it's the purpose of the loan that is important.
If you rent your old home out and borrow money to buy or build another home to live in, then the interest is not deductible, since the purpose of the loan isn't investment. Similarly if you borrow on your rental property to buy say a boat, the interest will not be deductible.
Some lenders and brokers have particular expertise in lending for investment.
How borrowing affects your investment return and risk
The larger the proportion of a property value you borrow, the larger the risk you face and potential returns you can earn. If you only have a little bit of equity, your own money in a property, then increases in the property value will magnify the returns on that money.
But it can also accelerate losses if values fall.
Apart from falling property values, other risks you need to consider are interest rate rises, long periods when you can't find a tenant, or if you lose other income you rely on to help support the loan.
Some investors set out to make a loss on their property investment, at least in the early years. This is called 'negative gearing'. It occurs when the income you earn from a rental property is less than the costs you face. The loss you make can be offset against tax you pay elsewhere, for example on a salary. Investors who make a loss on a property that is negatively geared are counting on capital gain to more than offset the loss over time. They are still losing money in the short-run, however.
Whether and when to repay the loan
Many investors who want to build up a number of properties take interest-only mortgages. This helps cash flow which can be used for upgrading properties so rents can be lifted, or to provide deposits for more property purchases. If you still have a mortgage on your own home, it allows cash to go towards paying this off.
If you only want one or two rental properties, you expect little growth in property values where you live, or you are nearing retirement, paying off investment property loans will help you reduce risk.
