The goal you have for a property you’re considering buying has a significant effect on your home loan. This is because there are major differences between home loans for investment purposes and home loans for owner-occupiers (those planning on living in the home).
The purpose of your home purchase can not only impact the interest rate a lender may offer you, but you may even find that one purpose offers significant benefits come tax time.
Let’s explore the key differences between investor and owner-occupier home loans, how they benefit home buyers and the downsides you may not expect.
Key differences between investment home loans and owner-occupied home loans
An investment home loan is a mortgage designed for those looking to purchase a property as an asset for the purpose of earning a rental income. Owning a property for investment purposes allows you to rent it out to earn passive income. Property is typically considered a growth asset class, as its enduring popularity in Australia allows for the potential higher returns on both capital growth and income.
Comparatively, if you purchase a home with the intention of living in it as your principal place of residence, this would make you an owner-occupier. Typically, if you’re taking out an owner-occupier home loan you’re likely paying a deposit -around 10-20%, or a loan-to-value ratio (LVR) of 80-90% – to secure the property, that would then be repaid over 20-30-years, unless sold prior.
When a home loan lender is assessing the application of an owner-occupier, it’s likely to analyse factors like the income and credit history of the applicant, as well as the size of their deposit. When it comes to an investor home loan, the lender will be taking into consideration additional factors, like:
- The potential rental income you may earn, and
- Projections of the likelihood of the property appreciating in value.
Generally speaking, there is a greater risk to lenders that an investor may not be able to service home loan repayments than an owner-occupier. After all, if you live in a home that is at risk of being seized by your bank, you’re more likely to ensure you meet your repayments. These additional factors above may help to determine the investor’s eligibility for an investment mortgage, as part of the lending criteria, as a lender must ensure the home loan can be serviced by the investors income, including forecast rental income.
What are the benefits of an investment home loan?
Whether you have one or multiple investment properties in your portfolio, not every investor seeks to purchase an investment property outright, as this is a considerable expense, regardless of the property you’re buying. Instead, purchasing a property by taking out an investor home loan may offer some competitive benefits that investors may want to consider.
‘Gearing’ in financial terms refers to borrowing money for investment purposes. The cost of the investment compared to any income earned from the investment will determine whether it is positively geared, negatively geared or neutral.
If your investment property was costing you more in deductible expenses, like interest charges on the mortgage and ongoing repairs, than the income you earned from rental payments, it would be considered to be a ‘negatively geared’ asset. Without an investment home loan, you would not be able to claim interest charges as a deductible expense.
In Australia, this scenario actually has significant tax benefits for investors. You may be able to claim this net loss against your taxable income – colloquially called “negatively gearing” a property. Some investors use this as a tax strategy, purposely working to ensure one or several properties are negatively geared so they may pay less come tax time. Negative gearing can therefore make purchasing property a less risky investment.
While this is not without its controversy, some experts argue that negative gearing has real-world benefits to renters in Australia. Without this tax strategy as an option, there may be less investors and therefore less properties available to lease. When the supply of rental properties falls, the cost of rents generally skyrocket.
Additional tax benefits
Not only can investors claim the interest charges on their investor mortgage as a deductible expense, but they may also deduct any lender fees, such as upfront fees or ongoing fees. Additional aspects of an investment property you may be able to deduct come tax time include:
- Cost of rental advertising for property
- Council rates (only eligible for period of time that property was rented)
- Body corporate fees
- Property depreciation (depending on the year the property was built)
- Maintenance and repairs, as they relate to wear and tear
Passive income could pay off your mortgage
Another significant benefit of taking out an investment loan to purchase property is that it allows you to earn a passive income when the property is tenanted. Purchasing a property outright can be an extremely costly exercise, even when looking at entry-level properties, such as apartments. If you choose your property carefully, and the rental income you earn covers your mortgage costs, you’ll effectively be able to have your tenants pay off your mortgage for you.
Any left over funds could go towards paying down the mortgage faster, meaning you’re one step closer to pocketing the entire rental income you’re earning from the property.
What are the downsides of an investment home loan?
It’s worth keeping in mind that there are some benefits to an owner-occupier home loan that investors do not see. Most significantly, when you purchase a property to rent out, you’re seen as a riskier customer to lenders. A lender may be more likely to offer an investor a higher interest rate on their home loan as a result, to help recoup the cost of the mortgage faster in the higher chance the investor may default on the loan, compared to a lower interest rate offered to an owner-occupier.
A lender may also be more scrupulous when it comes to an investors chance of approval for a home loan due to this perceived higher risk of default. There may be greater hoops to jump through, such as proof of income and rental yield projections, that investors must meet before they gain loan approval.
Additionally, as with any investment, there is a risk that you will not earn a return as a property investment may not always be tenable. There may be lulls in the market, or changes to the area that make it less desirable, such as major construction. It is a risk that your property may go weeks without tenants, not earning you a rental income. Depending on your financial situation, you may struggle to repay your investment home loan at this time, putting yourself at higher risk of default.
Further, it’s worth noting that the cost-saving grants and schemes offered by federal and state governments for homebuyers, such as the First Home Owners Grant, stamp duty concessions and exemptions, or the First Home Loan Deposit Scheme, are almost always reserved to owner-occupiers. You will likely need to generate the downpayment needed for the property yourself, whether through genuine savings or by leveraging the equity of another investment property. Alternatively, some investors will choose to live in a home for up to 6 months as an owner-occupier before switching over to an investment loan, to qualify for these government schemes.
Factors to compare in an investment home loan
When you’re comparing investment home loan options, it’s important to remember there are additional factors to consider that do not always impact owner-occupiers. With that in mind, these are some of the key factors to compare when searching for your best investor home loan.
|The home loan rate is a significant factor impacting the cost of a loan. Lenders may be more likely to charge investors higher interest rates as they are perceived as a riskier borrower than owner-occupiers. Consider looking at the comparison rate as well, as this factors in many of the fees charged, as well as the interest rate, to offer a more realistic idea of the cost of the loan.
|You may be charged several home loan fees, such as application fees and annual fees. Keep in mind that these fees may be tax deductible.
|Choose from principal and interest repayments (paying off both the loan amount and interest charges) or interest-only repayments (paying off just the interest charges).
Opting for an interest-only home loan is a common investment strategy to keep ongoing expenses down, particularly if you’re looking to flip the property for maximum capital gains.
Keep in mind that once the interest-only period ends, you’ll switch back to principal and interest repayments. As you did not reduce the loan amount owing in this time, just your loan term, your repayments will be higher.
|Home loan features, like an offset account or making extra repayments, can help to reduce the interest charges or principal owing on a home loan. The less interest you pay the lower your expenses, and the faster you pay off your mortgage, the greater your passive income earned will be.
|Interest rate type
|Choose between fixed home loans (locking in the rate for generally 1-5 years) or a variable rate home loan (subject to market fluctuation). Investors may need to judge the market carefully to ensure they choose the most competitive rate type, as you want to avoid being locked into a higher rate when interest rates are falling, but avoid watching your variable repayments rise when interest rates are on the up.
Alternatively, you could consider splitting your interest rate between fixed and variable.
There are significant differences between investment loans and owner-occupied loans that must be weighed up when you’re considering purchasing property. While investment home loans offer generous taxation benefits, you may not qualify for helpful first home buyer government schemes offered to owner-occupiers, and vice versa.
Whatever the purpose of your property purchase is, the best advice remains to do your research on everything from property prices, to rental yields and vacancy rates in your area, as well as comparing home loan interest rates, fees and features offered.
Any statements are general in nature and do not take into account your financial personal situation, objectives or needs. You should consider whether any statement/s is suitable for you and your personal circumstances. Before making any financial decision, consider your circumstances and the product disclosure statement.