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What you need to know before converting your home into a rental property

What you need to know before converting your home into a rental property

There are many reasons why you might want to move house. Perhaps you found a job in a different city, or your family has grown and the house or apartment no longer fits your needs. Whatever may be the reason for the change, you don’t need to give up the home you own when you move to another. 

According to the Australian Taxation Office (ATO), you can continue to treat a dwelling as your main residence for up to six years for Capital Gains Tax (CGT) purposes, even if you don’t live in it and use it to produce income. This means you can rent out your primary home and return to it any time within six years and it will maintain its CGT-free status, with some conditions.

What to consider while turning your home into an investment property

If you plan to switch homes, you may consider renting out the home you own as an investment property. This may help build an extra income stream. Still, it’s essential to weigh the benefits and costs and consider your circumstances before deciding to rent out or sell your primary home. For instance, it is worth considering the rentability of your home and the tax implications of converting it into a rental property. 

Determining the rental appeal of your home

It’s easy to overestimate your home’s desirability for the simple reason that you’re emotional about it. But you could try not to overlook the practical aspects and objectively analyse your property’s rental appeal vis-à-vis the location, condition, neighbourhood and other such factors that might impact the rental yield. 

Additionally, you also need to consider the demand for rentals in your area and whether the property will bring in an adequate amount of rent to cover your existing mortgage. Furthermore, you may need to check whether you need to carry out any maintenance or repairs before renting out the property – an additional cost that will add up to your expenses.

To cut the long story short, it is a good idea to research the market and critically evaluate your property’s rentability and other associated costs before deciding whether it’s worth holding on to it or not.

The tax perspective

When you take out a home loan to buy an investment property, you’re eligible for a tax deduction on the interest you pay on your mortgage. Turning your residential property into an investment property by renting may mean changing your home loan to an investment loan. This is something to speak to your lender about as investment loans often have different terms and rates. If you do switch your home to an investment property, it’s possible to claim a tax deduction for the interest you pay on your home loan once you rent it out to a tenant. 

You can, of course, use the equity in your home to buy a second property, but the interest on your new mortgage won’t be tax-deductible if you convert your first home into an investment property. By changing your existing home loan to an investment loan, you’ll probably be claiming a tax deduction on a smaller debt as compared to the new mortgage you take out for the second home.

In case you don’t intend to return to your old home, you might also have to pay CGT when you sell it later as you cannot retain the CGT-free status of your residence if you don’t move back within six years. 

Changing your home loan from an owner-occupied to an investment loan

If you’ve decided to use your home as an investment property, you’ll need to notify your lender that the property is no longer owner-occupied. That’s because a different mortgage product might apply for an investment property. For instance, your lender might switch you to an investment loan with a higher rate of interest. If you’ve been a long-term customer, this may be negotiable and it’s always worth asking about a rate reduction. 

Besides a potential hike in the interest rate, an investment loan might also offer a different set of features than an owner-occupied loan. An experienced mortgage broker can help you determine the right loan structure for your home and also guide you with the paperwork for changing your home loan into an investment loan. Furthermore, if you wish to use the equity you have built up in your home to buy a second property, your broker can guide you through the various options available. 

Generally, lenders will provide you between 60 per cent and 80 per cent of the property value as the loan amount. However, you may be able to borrow a higher percentage of the property value from the same lender compared to a different lender. It would help if you also worked out your cash flow in advance, as lenders need to be convinced that you’d be able to service both mortgages comfortably. You may connect with a mortgage broker if you need assistance in crunching the numbers and determining the right home loan product for your needs.

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This article was reviewed by Kate Cowling before it was published as part of RateCity's Fact Check process.

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