What is a investment property loan?
An investment property loan is a mortgage obtained for the purpose of buying a property you do not intend to live in, but hope to make a return from. Like sharemarket investing, property investors enter the market with the hope 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?
When you're an owner/occupier, your lender knows you will be living in the property for which they have granted a mortgage. There are a number of points a lender will take into account before offering you a loan to purchase a property. These include:
- The value of the property you want to buy
- How much you want to borrow
- Your credit history, especially in terms of regular repayments
- Your income
The same questions will be asked when you apply for an investment loan, but a potential lender will require additional information as detailed below.
Investment loan questions
For an investment loan (buy to rent) a lender is likely to ask you to prove that you have enough money set aside or sufficient regular income so that you can manage the mortgage repayments if a property is unoccupied for some reason. As you will be relying on rental income to pay off the loan, you need to bear in mind that there may be fallow months when you are changing over tenants, and there might be hefty expenses involved in preparing the property for reoccupation. These all eat into rental income, so your lender will want to be sure that your calculations are as accurate as possible.
The lender will also be aware of the potential for a rise in the value of your property asset over a period, but will also consider information about vacancy rates in your area and any trends in property prices.
Two-tier market: Why lenders charge investors higher rates
In 2015, the Australian Prudential Regulatory Authority (APRA) raised concerns about the growth of the investment housing market. It 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 investor rates.
With an investment property loan, as opposed to an owner/occupier loan, the lender is effectively buying into a higher risk, as you will be engaging in a different business transaction.
Other types of investment loans
As well as the standard mortgage loans you can take out with financial institutions, you could also examine other options.
A line of credit is a borrowing limit that a lender can give you where, when you have repaid the money, more funds can be borrowed according to need.
If you have a self-managed super fund (SMSF), you may also be able to buy an investment property in your fund, but will likely pay a higher interest rate.
Fixed vs variable rates: what is the difference?
Investment property buyers have a choice between fixed or variable interest rates. Which pathway they choose depends on a variety of factors, including personal risk tolerance and whether the official cash rate is rising or falling. A fixed interest rate allows the investor to lock in a set repayment amount for a set period of time – usually between 1 and 5 years. A variable interest rate, meanwhile, can be changed by the lender periodically and is often influenced by what the RBA does when it meets on the first Tuesday of the month.
What are the potential rewards of property investment?
Return on investment
The ultimate goal of investing in property is return above the original investment. There are two ways to achieve that: The first is to sell for a higher price than the price you buy it for, and the second is to earn income from your property by renting it out to tenants. Because the property market is imperfect, there is a chance you could sell your property for above its true value.
While no investment is ever 100 per cent safe, the property market is generally less volatile than other markets, like the sharemarket, which can rapidly lose value due to circumstances outside of the investor’s control. Property transactions are slower than sharemarket transactions.
Property investors may be eligible for a number of tax benefits, including capital gains discounts, capital gains offsets, deductions for repairs and maintenance if and when the property is tenanted, and 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 which are exposed to boom and bust sectors, such as mining.
Costs outweigh return
Sometimes property investors have to spend a lot to make their investment property habitable for tenants or to improve its value when the property is sold. These costs could outweigh the return you receive on your investment if they do not improve the property’s capital growth or rentability.
Unable to sell or lease
Property investors face the risk that their investment property will not appeal to buyers or renters and as such, they will not receive a return on their investment.
Potential return sources
Capital growth is the increase in value of your property over time. If the amount your property sells for is higher than the amount you bought it for, you have achieved capital growth.
Rental income is the amount your tenant pays you, usually on a monthly basis, to live in your property.
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 $150,000.
Where to invest: Considerations
When you’re choosing where to invest, as opposed to buying an owner-occupier property, you generally have more flexibility because the property does not have to match your taste or even be in an area you’d like to live.
Here are some other factors you may wish to consider before choosing where to live:
- Growth – Have properties in your desired 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 over a period of time on their investment. However, if you are unable to make a profit because your costs outweigh your return, that’s called negative gearing.
Investors with negatively geared properties may be able to reduce their taxable income.
Negative gearing has attracted controversy over the years, with some commentators blaming it for housing affordability problems in major capital cities.