Everything You Need To Know Before Making A Home Loan Investment

Venturing into the world of property investment can be an exciting, yet risky, endeavour, and it can literally pay in value growth to ensure you’ve done your research before purchasing your first or next home.

Let’s explore the most significant factors every investor needs to be aware of before they purchase an investment property, including how to choose their best property and what to look for in an investment home loan.

 

The benefits investing in property

It’s crucial that you are realistic about the advantages and risks of investing in property in Australia before you sign on the dotted line. There are a number of worthwhile benefits of investing in property in Australia, when done right, including:

  1. Earning a passive income

    Investing in a positively geared property, that you can lease to tenants who pay you a rental income, is considered to be a popular form of ‘passive income’. This term simply means that it is an “easier” income than a traditional 9-5 job, for example, and requires less labour or effort on your part. Once your mortgage is paid off, the rental income you earn from an investment property can be significant, and help grow your overall portfolio and/or be used to finance a comfortable lifestyle.

  2. Growing your portfolio

    Property is one of the more common asset classes one can invest in. By doing so, you may be able to grow your investment portfolio and therefore the potential returns you gain through these assets, such as stocks, bonds or cryptocurrency.

  3. Tax benefits

    There are a significant number of tax benefits available when you own an investment property. This includes being able to deduct a number of expenses, such as interest charges on a mortgage, or upkeep on the property, come tax time. Further, if the property costs more to maintain than what you earn in rent, the property will be considered ‘negatively geared’. In Australia, this means you may be able to offset the net rental loss against your income, to reduce your taxable income over a financial year.

Keep in mind that while you may be able to claim tax deductions on expenses, property investors will still have to pay for these costs upfront. Additionally, if your property is positively geared (meaning it generates more rental income than its ongoing expenses cost you), you will need to pay tax on your rental income.

The risks of investing in property

Property investment may be considered “safe as houses” and a more low-risk option, but there is always some risk associated with any investment. When it comes to your first or next investment property, the most common risks include:

  1. Fluctuations in the market

    There is no guarantee that your property value will continue to grow at the same rate recorded when you purchased it. It’s wise that would-be investors prepare themselves financially for any fluctuations in the market, whether that be macroeconomic factors, such as rising interest rates putting downward pressure on property prices, or local factors, such as major construction around the property reducing tenant interest. That being said, investing in property in Australia is considered by many experts to be a more safe option, historically, with some noting that prices have doubled nearly every decade.

  2. Tenants

    A property may not be tenable 100% of the time, whether due to lulls in the market or factors out of your control, such as the aforementioned construction example. Further, it’s not uncommon for investors to face issues with tenants, including late or non-payment, damage to the property, and any legal issues they create. While you can vet the tenants you lease to in the application process, there’s no guarantee issues won’t arise.

  3. Interest rate hikes

    If you’re servicing a mortgage for your investment property, this is a considerable expense to factor into your budget. If interest rates were to rise – as they should do over a 20-30-year mortgage – the amount you’ll pay in mortgage repayments will rise, and the return you’re earning from the property may decrease. While you can deduct some of the interest charges come tax time, some investors may consider increasing their rental costs at this time to make up for the higher repayment amount.

 

How to pay for an investment property

First things first, you’ll need to squirrel away your savings to get your foot on the investment property ladder. And unless you already have the cash flow to purchase a home outright, you’ll need to save up a deposit to qualify for an investor home loan.

Investment loans are mortgages specifically for those investing in property as an asset. Unlike homeowners that live in the property (owner-occupiers), investor home loans can carry much heavier scrutiny in the application process. This is because investors are considered to be more risky borrowers, as there is more volatility in the property market for investors than owner-occupiers that could impact their ability to repay a mortgage. Put simply, if your financial conditions change, you’re more likely to meet your mortgage repayments on a home you’re living in than an investment property.

What this means for your investment property deposit?
It may be worthwhile saving a larger sum to present yourself as a more reliable borrower – typically 20% of the property value. A higher deposit amount typically showcases a greater level of financial responsibility to a lender, and it also means that your loan-to-value ratio (LVR) will be lower. This is good news for any investor, as having a lower LVR generally means you may qualify for more competitive interest rates on home loans (more on this below). Plus, you won’t have to pay costly lender’s mortgage insurance (LMI), which can climb into the tens of thousands of dollars range, depending on the value of a property.

If you already own property, you may be able to leverage some of the equity in the existing property as security on your next property purchase. A home loan lender will typically lend you 80% of the value of your home, minus the debt you still owe against it – also known as your ‘useable equity’.

Summary:

Investors can typically pay for a property in one of two popular ways:

  • Save up a deposit – 20% or more is considered ideal
  • Leverage the equity in an existing property as security for the new property purchase

How to choose your ideal investment property

You’ve weighed up the pros and cons and saved up a deposit for your investment property. Now comes the fun part – choosing your property.

Searching through real estate opportunities can be some investors’ idea of a perfect weekend, but for others, knowing exactly where to look to find a gem can take some time. You’ll want to find the right balance of affordability, high rental yield forecasting, low vacancy rates, and livability. However, there are numerous resources and tools at your disposal to help you do just that.

Here are some of the key ways investors can compare potential properties and analyse which options best suit their portfolio:

  • Look for areas of growth

    One of the first steps in identifying a competitive investment property is looking for areas where you may expect to see increasing levels of capital growth. Speak to real estate agents for professional advice about up and coming suburbs, including locations where there is a growing population, or new public transport infrastructure is being built.

  • Rental yield trends

    Hop online to sources like Domain or RealEstate.com.au and review rental yield trends in areas you may be interested in. These figures can help paint a picture of which suburbs to potentially invest in. While past performance is not indicative of future returns, it may be influential to see which suburbs have experienced greater returns, or recent drops.

  • Vacancy rates

    Another key data point to consider are the vacancy rates in an area you’re interested in. When vacancy rates are low, you’re less likely to experience periods of gaps between tenants. Further, in a lower vacancy rate environment, higher demand from tenants for property means investors may be able to increase rental prices.

 

Worthwhile speaking to the locals

It’s always worthwhile speaking to the locals in any area you’re considering purchasing in, including real estate agents or mortgage brokers. Not only could you find a would-be seller, but you could discover details only locals know, such as which properties to avoid because of non-ideal neighbours. Also, consider future-proofing your property by researching any future development plans in the area that could lower its value. For example, in Sydney’s inner-west, the WestConnex infrastructure project caused nearby homes to fall in value by up to 17.2% at the time of construction.

Further, as maintenance and upkeep is one of the biggest ongoing costs associated with investing in property (outside of a mortgage) it’s worth considering the benefits of turnkey properties. Unless you have the budget for renovations, older homes in Australia generally cost more to maintain so they stay liveable for tenants. For example, tree roots can creep into piping, causing blockages and major damage that you must rectify.

There are other costs worth keeping in mind when you invest in property that may impact the overall rate of return, including:

  • Stamp duty
  • LMI (if your deposit is below 20%)
  • Council rates
  • Water rates
  • Conveyancing fees
  • Legal fees
  • Building insurance
  • Landlord insurance
  • Body corporate/strata fees
  • Land tax
  • Capital gains tax (if selling at a profit)
  • Property management fees

Comparing investor home loans

If you’re looking to invest in property but will be relying on a home loan to finance your purchase, choosing a competitive and affordable option can be one way to keep your expenses down.

  1. Interest rates

    The lower the interest rate, the lower your home loan repayments, and the more rental income you can pocket, or reinvest. As mentioned earlier, home loan lenders can reserve their lowest interest rates to investors with large deposits, so consider saving up a deposit of 20% or more before applying.

  2. Fees

    Consider home loan options that do not charge high ongoing fees (or any), including monthly fees, annual fees, extra repayment fees and more. For example, Reduce Home Loans Investor Rate Slasher does not charge an annual fee.

  3. Features

    Having access to features may help some borrowers reduce their repayments and interest charges, including the ability to make additional repayments, an offset account or a redraw facility. Some lenders may charge a higher rate for a home loan with features, however, Reduce Home Loans offers features on every single product, regardless of whether it is a ‘no-frills’ basic low-rate home loan.

  4. Repayment type

    Choose between paying both the principal (amount owing) and interest, or interest-only for a fixed period of time. Some investors opt for interest-only repayments as an investment strategy, as your expenses are considerably lower in this period. However, unless you flip the home and sell it within the interest-only loan window, your repayments will revert to principal and interest, and are likely to be much higher than before.

  5. Interest rate type

    Choose between paying a fixed interest rate, locked in for a period of generally 1-5 years, or a variable interest rate that is subject to market fluctuation. Fixed rates typically mean stability in your budgeting as your repayments won’t change over that fixed term, but if interest rates fall, you’ll miss out on a rate cut that variable rate customers will benefit from.

You’ll also need to ensure that your financial situation is healthy, as lenders will be assessing your loan application with a fine-tooth comb. It may be worthwhile to request a free copy of your credit score and/or credit history from one of the leading Australian credit reporting bureaus to ensure you’re in a strong position to gain loan approval. Lenders typically favour borrowers with good to excellent credit scores, so double check yours is healthy before you apply.

Other financial health factors lenders will take into account include:
  • Your income, including any generated from existing assets.
  • Your expenses, including living expenses and utilities, through to discretionary spending, like regular take-away meals.
  • Existing liabilities, including your credit card maximum limit, outstanding personal loans, HECS/HELP debts, and more.
  • Negative gearing benefits, as lenders will calculate your serviceability based on the potential of this.
  • Employment length, as being employed longer than a probation period of 3-6 months (regardless of your income) is considered to be more stable.

Taking the next step in home loan investment? Why not contact our friendly team of experts at Reduce Home Loans today and see how we can help.

 

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.

1300 733 823