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Refinancing your home loan to buy an investment property


Patricia Babalis

Patricia Babalis

( 9 min read )

If you have been paying down your mortgage consistently while living in your property, you may be considering using your available equity to secure an investment property. While this strategy comes with its risks, there is also great reward to be had in a successful investment.

Of course, there is no point in diving into an investment which you can’t afford that may leave you in over your head. There has to be a balance between the risk you take on and the potential upsides. Reducing your outgoing expenses, so that you free up more income, can be one strategy to reduce the risk of taking on more debt. One way of doing this could be to refinance your existing home loan to a lower interest rate to use the monthly savings to put towards paying off your investment property.

Before you get to this point, however, taking the time to ask yourself some tough questions and get all the right information is the best place to start.

Can you afford it?

The first question to ask yourself should be if you can afford to take on more debt and how it will affect your life if you do. Take the time to work out the answer to this question carefully, as taking on debt that you can’t comfortably afford will have serious implications for your financial situation.

First, look at the amount of useable equity you have in your current property and see if this will be able to serve as a deposit for the investment. You should ideally have 20 per cent of the investment property’s value as a deposit. This size deposit means that you will avoid lender’s mortgage insurance and reduce the bank’s concerns about the potential risk of taking on more debt.

What is useable equity?

Useable equity is around 80 per cent of the value of your property minus any debt still owing. Lender’s won’t usually allow you to borrow the full value of the property in case market prices drop and your loan ends up bigger than the value of the house.

How to calculate:

If your property value is = $880,000

And your current outstanding debt is = $300,000

$880,000 x 0.8 = $704,000

$704,000 – $300,000 = $404,000

Useable equity = $404,000

 

Equity isn’t everything, however, as you will also need to have sufficient income to service both home loans. This means that your income will need to be able to pay both loans and still meet your everyday living expenses which the bank will closely examine. Keep in mind that if you have other credit in the form of personal loans, car loans and credit cards, this will reduce your borrowing capacity. This is why it may be a good idea to refinance your existing owner-occupier loan to a lower rate to free up some extra cash to add to your useable income.

If you are still in the early stages of determining whether you can afford an investment property, then you should use a mortgage calculator to estimate what your monthly repayments would be. Once you have an estimate of how much you will need to borrow, and at what interest rate, you can mock up what your monthly repayment schedule will look like and see how that would fit into your current budget.

After you use the calculator to determine how the repayments will fit into your budget, you need to also factor in an emergency savings buffer. This should be the deciding factor in whether you can afford an investment property. If you won’t have spare cash to put aside for an emergency, such as unplanned time off work, then the potential consequences if you lose your income for a period of time can become catastrophic; from losing your investment property to losing the roof over your head. You should be able to put aside enough cash to cover repayments on your owner-occupier loan and investor loan for at least three months to guard against a situation such as this.

EXAMPLE – Yusuf looks to invest

Yusuf and his wife Semira have been paying off the house they live in for ten years and have built up enough useable equity to make up a 20 per cent deposit on an apartment for an investment property. The apartment is close by and could potentially also be used by the couple’s children in the future or their parents as they get older. In the meantime, the apartment has two bedrooms, a car spot, is close to shops and has a train station nearby.

Yusuf believes they will have no trouble renting it out to help with the monthly repayments. Yusuf heads online to use a mortgage calculator to see how much his home loan repayments will cost each month if he refinances to a larger loan. Yusuf sees that even though the monthly repayment size will increase significantly by refinancing to a larger loan size, the couple’s combined income and the potential rental income could still cover the payments with enough money to spare for comfortable everyday living.

With a further $20,000 stashed away in savings, Yusuf judges that he will also be covered for emergency situations in which he cannot make mortgage repayments for a few months. Yusuf believes he may be in a good position to invest, however, he decides to get some professional financial advice before he commits to taking on more debt.

 

What benefits will you get?

Taking on the added debt of an investment property would hardly be worth it without the benefits you expect to gain from the property. It is important to keep in mind that these benefits come from keeping the property long term and the potential increase in property value. The initial years of your investment will most likely see you run your property at a loss. In this situation, you may be able take advantage of negative gearing and claim your losses against your income for tax purposes.

Rental income is another potential benefit of having an investment property and can be crucial to many people’s investment plans. If you are planning on renting out your property, then getting a rental estimate letter from the real estate agent who currently looks after the property will give you an idea of the potential rent you could earn. Making your own assessment or getting a professional opinion as to the desirability of your potential investment property’s location for renters is also advisable. You don’t want to have the hassle of constantly looking for new tenants to fill your property, especially if the rental income is a big part of your loan repayment plan.

What are the risks?

With every investment there comes a level of risk. Your lender will play a big role in assessing the amount of risk you are taking on by borrowing for an investment property and many different factors will be taken into account. Potential risks include property value growth being less than expected over time or defaulting on your loan due to a lack of income.

Defaulting on your loan can be caused by many, often unpredictable, lifestyle factors, including loss of income, or external factors such as reduced rental desirability in the area of your investment. These risks need to be factored in to your decision before you take on more debt. The more back-up plans you can have in place, like an emergency fund, investments in other assets and diverse income streams, the more secure you will be if something does happen to go wrong.

There is also a chance of being rejected on your refinancing application if the bank deems the amount requested to be too high risk. This can damage your credit score which can have long term implications for your borrowing capacity.

Ready to commit

Young couple sitting on the floor and looking at the blueprint of new home.

If you do decide you want to purchase an investment property, you will need look for investment loans that will suit your needs. Having a loan pre-approved before you begin looking for a property will give you the confidence to go in and bid confidently on properties you may be interested in.

Investment property home loans 

At this early stage of your loan search, you have the choice of remaining with your owner-occupier lender for your investment loan as well or shopping around for the lowest rates on the market. If you have a sizeable deposit and a secure income, chances are that multiple lenders will be interested in your business meaning that you can look for competitive interest rates.

Shopping around for a good rate also gives you an opportunity to consider which features you have been using with your current home loan and which features you would like in your investment loan. For example, if your current loan caps the amount of extra repayments you can make per year, then you may wish to find one that will allow you to make unlimited extra contributions. Alternatively, you may wish to find a loan that gives you fee-free access to a redraw facility or offset account.

While you are researching and comparing investment loans you will likely get a good idea of what the mortgage market is currently offering in terms of owner-occupier loans as well. If your current home loan rate does not seem to be competitive then this is a great chance to consider refinancing your existing loan to reduce the size of your monthly repayments and increase your useable income.

Even though refinancing your loan will most likely come with some initial costs, and require your time in the research and application phase, a switch to a low rate lender will generally save you money in the long run.

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