What is an investment loan?
An investment loan is a type of home loan that someone takes out to buy an investment property. It is a mortgage solution for those who want to buy a property and rent it out to receive income from it, but can’t afford to buy the property without a loan.
Many things about investment loans are different to how standard home loans work because they have stricter eligibility requirements. Investment loans often require a higher loan-to-valuation ratio (LVR), meaning investors need to raise a larger deposit before applying for a loan. They also have a slightly higher interest rate on average than residential home loans do.
Expenses that you make for your investment property can be claimed as tax deductions to reduce your taxable rental income while you’re renting it out, and your capital gains tax if you sell the property. The tax deductions you can claim for an investment property include:
- Interest on the investment loan
- Home and contents insurance and landlord insurance
- Real estate agent’s commission
- Maintenance costs
- Council rates
- Decline in value of depreciating assets
- Construction costs (“capital works”)
- Travel expenses to the property to do an inspection, maintenance or repairs
Who can buy an investment property?
Recent statistics from the Reserve Bank of Australia show that young people are increasingly getting involved in property investment. 30% of property investors are under 40 years old, and another 60% are under 50 years old. About half of all property investors have a household income under $100,000.
There are some important restrictions on who can purchase an investment property in Australia. In short, Australian citizens can buy as many investment properties as they can realistically afford to pay for, and those properties can be established or new dwellings or vacant land to build on.
Residents who are not citizens can buy one established dwelling to live in, plus new dwellings or vacant land for an investment property. They cannot buy established dwellings as an investment property.
Non-residents can only buy new dwellings, off-the-plan properties that are under construction or not yet built, and vacant land for building on. They cannot buy established dwellings as an investment property.
These restrictions are a good thing for the Australian property market. It keeps our housing market more affordable by making sure that established dwellings are more available for first home buyers and owner occupiers to buy, and not for investors who would rent out the property.
What to look for in an investment loan
Interest rates for investment loans are typically slightly higher on average than interest rates for residential home loans. Investors should always consider more than just the interest rate that applies when considering the cost of an investment loan, of course.
There are several home loan fees and costs common to investment loans:
- Establishment fee: Charged as a one-off payment when you start an investment loan. (a.k.a. application, up-front, start-up, or set-up fees.)
- Lender’s mortgage insurance (LMI): This insurance is charged to the borrower, but it is effectively insurance for the credit provider in case the borrower cannot repay the loan.
- Ongoing fee: Charged on a monthly or annual basis to pay administration costs for the loan. (a.k.a. service fee or administration fee.)
- Discharge fee: Charged when you pay out your home loan in full. (a.k.a. termination fee or settlement fee.)
- Early exit fee: Charged if you pay out your home loan in full within a certain timeframe. (a.k.a. early termination, deferred establishment, deferred application, or early discharge fee.)
- Break fee: Charged if you switch from a fixed rate loan to another loan before the end of the fixed rate period.
Visitors to CANSTAR’s home loan comparison tables frequently search for features such as an offset account or redraw facility, and the ability to repay their mortgage faster with additional repayments.
CANSTAR also considers the following features that affect the value of a loan:
- Security and guarantee requirements
- Ability to make additional repayments, or a top up facility
- Redraw or transactional facility available
- Offset account available
- Split loan option available
- Portability feature allowing loan to transfer from one property to another
Sally purchased her first investment unit on the Gold Coast back in 2013, in preparation for the upcoming swell of people moving here or visiting for Olympic Games.
She has chosen an investment loan with low fees, but the interest rate is much higher than she would like, especially after comparing her loan to others listed on the CANSTAR comparison website. Now that she has repaid a considerable amount of her loan balance, she would also like to look for a loan that would not charge lender’s mortgage insurance (LMI).
After carefully doing her sums around what it would cost in break fees to switch loans at this stage, she is still confident that a lower interest rate would save her a significant amount of money in the long run.