What is an investment property loan?
An investment property loan is a mortgage used to buy a property you do not intend to live in, but hope to make a financial return from e.g. buying to rent.
Like share market investors, property investors enter the market hoping their investment will grow in value and deliver yield. Property tends to be considered a long-term investment, partly due to higher entry and exit costs.
What is the difference between an investment loan and an owner-occupier loan?
Investment home loans tend to have higher interest rates and fees than owner occupier home loans, and may also have tighter requirements around the deposit and security you’ll need to pay.
Many lenders charge more for investor loans than for owner occupier loans, because investors (who borrow to make money) are often considered to be at higher risk of defaulting on their repayments than owner occupiers (who borrow to put a roof over their heads).
The higher financial risk associated with investment lending also led the introduction of several Australian government regulations on investment home loans, further affecting their cost and availability to borrowers.
Even though owner-occupier home loans are often cheaper than investor mortgages, it’s important not to misrepresent your intentions when making a home loan application, as Occupancy Fraud can have serious consequences.
Investment loan questions
There are several questions a lender will ask before offering you a loan to purchase a property, including:
- What is the value of the property you want to buy?
- How much do you want to borrow?
- What is your credit history, especially in terms of regular repayments?
- What is your income?
These and other questions will be asked when you apply for any type of mortgage, including an investment loan. You may also be required to provide additional information.
Even if you plan to earn extra income by renting your investment property, your lender will likely require you to demonstrate you’d still be able to manage the mortgage repayments on your regular income without this rental yield.
While rental income can help you pay off a loan, there may be fallow months when you’re changing over tenants, other periods when the property is unoccupied, or hefty expenses involved in preparing the property for reoccupation. These can all eat into rental income, so your lender will want to be confident that you’d still be able to make your mortgage repayments independently of the rent you receive.
The lender will also assess whether your property is likely to rise in the value over time, considering information about vacancy rates in your area and any trends in property prices.
Two-tier market: Why lenders charge investors higher interest rates
When a lender provides an investment loan, they are effectively taking a higher risk than providing an owner-occupier loan, as an investor loan is a different business transaction, with a higher likelihood of a borrower missing payments and defaulting.
In 2015, the Australian Prudential Regulatory Authority (APRA) raised concerns about the growth of the investment housing market, and asked Australia’s biggest lenders to increase their capital reserves against their loan books.
Many lenders responded by changing the eligibility criteria for investor borrowers and by increasing investment property loan rates.
Additional APRA regulations came into effect in 2017, limiting the number of investment loans that banks and lenders can provide to borrowers.
The combination of these factors means that there are generally fewer investment loan options available than owner occupier loan options, and that these investment mortgages are more likely to have higher interest rates and fees.
Other types of investment loans
As well as the standard mortgage loans from financial institutions, there are other potential options to consider when investing in property.
A line of credit is a flexible means of borrowing money from a lender up to a set limit, much like a credit card. If you already have equity in one property, using this equity as security for a line of credit is one way to finance an investment property purchase, though there are risks involved.
If you have a self-managed super fund (SMSF), you may also be able to buy an investment property using money in your fund, but may pay higher interest rates for a specialised SMSF investment loan.
Fixed vs variable rates: what is the difference?
When you're looking for the best investment home loan rates, you often have a choice between fixed or variable interest rates.
A fixed investment interest rate allows an investor to lock in a repayment amount for a set period of time – usually between 1 and 5 years. This can help provide stability in a tumultuous market, and keep your budgeting relatively simple and straightforward, though you could potentially miss out on some savings if rates were to fall during the fixed period.
A variable investment interest rate can be changed by the lender, and is often influenced by the monthly decisions of the Reserve Bank of Australia (RBA) regarding the nation’s official cash rate. If rates fall, you could potentially save some money on your investment loan repayments, but if rates were to rise, you could find yourself paying more than you budgeted for.
What are the potential rewards of property investment?
Return on investment
The ultimate goal of investing in property is achieving a return above the original investment cost. There are two ways to achieve this:
- Selling the property for a higher price than you bought it for.
- Earning income from your property by renting it out to tenants.
While no investment is ever 100% safe, the property market is generally considered less volatile than other markets, such as the share market, which can rapidly lose value due to circumstances outside of the investor’s control.
Property transactions usually take longer to process than share market transactions, and property values generally grow or shrink more slowly, over longer periods of time.
Property investors may be eligible for various tax benefits, such as:
- capital gains discounts/offsets
- deductions for repairs and maintenance if the property is tenanted
- negative gearing
Intergenerational wealth transfer
Bricks and mortar property investments are sometimes made to allow families to bestow wealth to their beneficiaries.
What are the risks of property investment?
Not all property markets rise and there is a risk that your investment may not yield the results you expect. This risk may be more pronounced in suburbs exposed to boom and bust sectors, such as mining.
Costs outweigh return
Sometimes property investors spend a lot to make their investments suitable for tenants, or to improve a property’s value before it’s sold. These costs could outweigh the return you receive on your investment if they do not sufficiently improve the property’s capital growth or rentability.
Unable to sell or lease
Property investors face the risk that their investment will not appeal to buyers or renters, and that they will not receive a return on their investment as a result.
Potential return sources
Capital growth is the increase in your property’s value over time. If your property sells for more than what you bought it for, you have achieved capital growth.
Case study - capital growth:
Margaret bought a unit in 1993 in the Sydney suburb of Pyrmont for $300,000. In 2016, she sold that same property for $750,000. Her capital growth was $450,000.
Rental income is the amount your tenant pays you, usually on a monthly basis, to live in your property.
Where to invest: Considerations
Choosing where to invest is different to choosing where to live, and involves considering:
- Growth – Have properties in the area grown or fallen in value in recent years?
- Other economic factors – Is the area exposed to one industry? If so, is that industry on a growth trajectory, or declining in value?
- Social factors – Is the area appealing to potential renters? Does it have good public transport infrastructure? Is it close to schools and medical facilities?
What is negative gearing?
Investors borrow money with the intention of making a profit on their investment over time, which is sometimes called positive gearing. However, if you are unable to make a profit because your investment costs outweigh your returns, that’s called negative gearing.
Investors with negatively geared properties may be able to effectively reduce their taxable income, and enjoy certain tax benefits as a result.
Negative gearing has attracted controversy over the years, with some commentators blaming it for housing affordability problems in major capital cities.