Blue Chip Mortgages Port Macquarie Finance

INVESTMENT LOANS

GUIDE TO INVESTMENT LOANS

The types of loans available for investment properties are generally the same as the ones available for owner occupied properties - you can avail yourself of the same interest rates, options and flexibility. The key to determining which loan is best for your investment property comes down to your investment strategy.

As with any large financial decision you make, it's always wise to seek investment advice from a professional before entering into any property investment. There are plenty of people in the financial services and mortgage industries who can help you with this, your accountant, financial planner and MFAA accredited member.

The two primary ways in which investors build wealth through real estate:

  • Capital Gain
    This relies on the increase in value of the property to be more than the initial price of the property plus your repayments and buying and selling one-off costs. For example, if you purchased for $200,000, you sold it for $300,000 and your repayments and additional costs were $60,000 the gross capital gain is $40,000.
  • Building Equity
  • This relies on an increase in value of the property and bringing down the loan. For example, if you purchased a property for $200,000, and your loan was for $150,000 you would have $50,000 equity in the property. A few years later if the property was valued at $225,000 and you had $100,000 remaining on the loan you have $125,000 equity in the property. Plus you benefit from the rental return on the investment property.

Here's some tips to help you choose an investment loan:

1. YOUR INVESTMENT STRATEGY

First, set your financial goals and investment strategy - are you looking at a long term or short term gain? Do you want to take a passive or aggressive approach? For example, are you looking to own a few properties where you can live comfortably off their rental income or, are you looking to build a portfolio of properties which you can sell, cash up and move to the south of France? Will you structure your repayments to pay off the loan as quickly as possible or structure them in order to obtain a tax benefit?

There's plenty of information available about investing in property - devise a plan with your financial advisor or accountant, or to determine a strategy yourself.

2. YOUR LOAN OPTIONS

Second, research the types of loans available so you can explore all options when talking to your mortgage provider. Some of the more popular loan choices for investments are:

Interest Only Loan

This loan allows you to structure you payments where you are only paying off the interest accrued on the amount borrowed - the repayments are a lot less than those for a principal and interest loan. They are usually taken over a normal term (i.e. 25 years) with the interest only option being 1-5 years, and renegotiated after 1-5 years.

Tip: These loans are suitable if the investor is relying on a capital gain in the short-medium term.

Introductory Rate or 'Honeymoon' Loan

This loan is attractive as it offers lower interest rates than the standard fixed or variable rates for the initial (honeymoon) period of the loan (i.e. six to 12 months) before rolling over to the standard rates. The length of the honeymoon depends on the lender, as too does the rate you pay once the honeymoon is over. This loan is usually flexible allowing you to pay extra off the loan. Be aware of any caps on additional repayments in the initial period, of any exit fees at any time of the loan (may be high if you change during or immediately after the honeymoon), and what your repayments will be after the loan rolls over to the standard interest rate.

Tip: These loans are attractive to an owner-builder or DIY investor who in the short term will use the property as a principal place of residence and use their skills to add value to the property at the same time building some equity in the property. After the renovation they can seek to sell for capital gain or keep it, rent it, and build further equity in the property.

Line of Credit/Equity Line

This is a pre-approved limit of money you can borrow either in its entirety or in bits at a time. The popularity of this loan is its flexibility and ability to reduce loans quickly. They usually require the investor to offer security for the loan i.e. principal place of residence or another investment property. A line of credit can be set up over a normal term (i.e. 25 years) with the line of credit option being 1-5 years or revolving (longer terms) and you only have to pay interest on the money you use (or 'draw down'). Interest rates are variable and due to the level of flexibility are often higher than the standard variable rate. Some lines of credit will allow you to capitalise the interest until you reach your credit limit i.e. use your line of credit to pay off the interest on your line of credit. Most of these loans have a monthly, half yearly or annual fee attached.

Tip: These loans are very popular with all types of property investors. For those building a property portfolio and are constantly on the look out for the next bargain in a growth area, they have a loan approved and waiting. For the renovator, they only have to pay interest on the money when they draw it down in each step of the project. For those out for a capital gain they can use the line of credit to purchase the property then use it to make the repayments on the property. For both investors all income is put into the line of credit to bring down the principal and interest in the loan and build equity in the property. Longer term investors may want to change a line of credit loan to a principal and interest or variable rate loan to avail of their cheaper interest rates.

These loans are suited to people who are financially responsible and are usually on high incomes.

Redraw Facility

This loan allows you to put additional funds into the loan in order to bring down the principal amount and reduce interest charges, plus it gives the option to redraw the additional funds you put in at any time. Simply put, rather than earning (taxable) interest from your savings, putting your savings into the loan saves you money on your interest charges and helps you pay off your loan faster. Meanwhile, you are still saving for the future (or your next investment property). The benefit of this type of loan is the interest charged is normally cheaper than the standard variable rate and it doesn't incur regular fees. Be aware there may be an activation fee to obtain a redraw facility, there may be a fee for each time you redraw, and it may have a minimum redraw amount.

All In One Accounts

This is a loan which works as an account where all income is deposited in the account and all expenses come out of the account. The benefit of the All In One Account is its ability to reduce the amount owed and thus the interest payments while providing a one-stop finance shop where your loan, cheque, credit and savings accounts are combined into one. Normally these loans will be at the standard variable rate or slightly higher and may incur monthly fees. Be aware that if the account is split into the loan account, with credit, cheque and ATM facilities placed into satellite accounts, you will need to check your access to funds, how many free transactions you receive, and what associated fees the loan may have.

100% Offset Account

This loan is similar to an All In One Account however the money is paid into an account which is linked to the loan - this account is called an Offset Account. Income is deposited into the Offset Account and you use the Offset Account for all your EFTPOS, cheque, internet banking, credit transactions. Whatever is in the Offset Account then comes directly off the loan, or 'offsets' the loan amount for interest. Effectively you are not earning interest on your savings, but are benefiting as what would be interest on savings is calculated on a reduction on your loan. The advantages are similar to the All In One Account. These loans normally have a higher interest rate and higher fees due to their flexibility.

Tip: The above three loans are for the longer terms investor seeking to build equity through a property portfolio and being able to use the investment properties for tax benefits.

Split Loans

This is a loan where the overall money borrowed is split into different segments where each segment has a different loan structure i.e. part fixed, part varied and part line of credit. Often called designer loans, the investor benefits from one or more types of loans.

Tip: This type of loan is good for people who have one investment property and a principal residence, and who may be on the lookout for another investment property. The one loan for both properties can be split into three components, paying principal and interest on the principal residence and interest only on the investment property, plus having a line of credit option if seeking to purchase a second investment property.

Construction Loans

These loans are tailored to those building a home when you don't need the entire amount from the start - you only pay interest on what you've spent over the stages of construction.

Bridging Loans

These loans are for when the sale of an existing property takes place after the settlement of a new property - when you want to buy a new investment property before selling the old one, where the funds from selling the existing investment are paid straight into the loan for the new investment property.

3. YOUR LOAN PROVIDER

Now you've got your strategy and have researched the loan choices available to you, the last step in the process is to select your loan provider and work with them to determine the best type of loan for your circumstance and strategy.

 

Disclaimer: This document is for information purposes only, and must not be relied upon as a substitute for professional services or legal advice.