Money - 19 Oct, 2020

Home loan questions to ask before buying your first investment property

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Decided to dip your toes in the investment property market and wondering what your financing options are? Here are the key home loan options.

It’s undeniable 2020 has been a rollercoaster ride, and CoreLogic reports monetary policy and financial regulation has sharply shifted in response to COVID-19, refocusing their policies from implementing a more conservative lending environment to ensuring high levels of liquidity among lenders and ensuring low-cost debt so as to encourage spending. 

When it comes to choosing the right home loan product for your investment property, it’s an exercise in weighing up the pros and cons of the various product types, then the various lenders. Here is our handy guide to the key home loan types, and their pros and cons

What is a line of credit home loan?

A revolving credit facility, a line of credit home loan gives you access to a pre-approved level of credit whenever you need it – essentially allowing you draw on the equity in your home without having to apply for a new loan each time you want to access it.

What are the terms of a line of credit loan?

A line of credit allows you to withdraw funds up to the agreed limit, and you’ll only pay interest on any funds you withdraw. For example, say you have a line of credit of $100,000, and you pull out $30, 000 for a deposit on an investment property. You will only pay interest on this $30, 000.

Interest is added to the line of credit loan each month and repayments are not necessary while the loan is within its credit limit. You can typically make interest-only repayments or let the interest be added to your home loan balance (capitalised) up to your approved line of the credit limit. Do note capitalising interest will mean you hit your approved line of credit limit earlier if you opt to only repay the inters.

You’re usually free to make as many repayments as you like, and some lenders will allow you to have your salary paid directly into the loan – you can pay your bills, make credit card repayments or withdraw cash from the loan account, similar to an offset account. 

How long does the interest rate last for a line of credit loan?

A line of credit interest rate is set for the life of the loan and must be paid off before the end of the loan term, which is typically 30 years.

Who is a line of credit loan suitable for?

A line of credit loan may suit borrowers who want to have easy access to funds to invest when opportunities arise, or homeowners undertaking renovations without fixed costs – meaning they can dip into only the money required to pay for works at their completion (say you expected renovations to range from $35,000 to $50, 000, with progress payments throughout the project. By setting up a line of credit for the $50, 000, you will only pay interest on the money you actually spend when you spend it, as opposed to a loan or remortgaging, on which you will pay interest on the full loan amount from the day you receive it.)

What are the advantages of a line of credit loan?

The key potential advantage of a line of credit is flexibility – both in when and where you spend the funds, and how and when you make repayments. It means you can jump on an opportunity when and where it appears, but only incur interest when you actually access them – not at the time the loan is granted, for the full total of the loan.

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What are the disadvantages of a line of credit loan?

If you struggle to stick to a budget or have a tendency to overspend, a line of credit could see you paying interest on the money you’ve accessed for the everyday cost of living expenses (meaning that new food processor or weekly bag of groceries has the added cost of any interest paid, much like spending on a credit card does – these loans tend to have higher interest rates than standard principal and interest home loans.)

Chat to an eChoice broker about the line of credit loans for investment properties!

What is an interest-only home loan?

With an interest-only home loan (mortgage), your repayments only cover the interest on the amount borrowed (this is called the principal) for a set period of time. At the end of this time, you’ll move back to repay the interest and the principal. Bear in mind by paying interest only, you will not be reducing your loan at all.

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What are the terms of an interest-only loan?

While the fine print will be determined and outlined with your lender, interest-only loans can be for the entire time of the loan, which is to be paid back in full at the time the loan ends (either the term of the loan or because you sell the asset attached to the mortgage) or be for a set period of time with the loan then reverting to principal plus interest.  

How long does the interest rate last for an interest-only loan?

This will be determined by your lender, however, these types of loans can be long term where you are only expected to pay the full amount at the end of the loan – for example, when you sell an investment property.

Who is an interest-only loan suitable for?

Interest-only loans may be more difficult to secure, especially for longer-term loans. That said, applicants with a decent deposit for their investment property and a plan to turn it around quickly may find it opens up the opportunity to get into the investment market (you will need to include interest-only repayments to the cost of the investment property project, so every month means an additional expense.)

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What are the advantages of an interest-only loan?

This type of loan can help you finance shorter-term projects – for example, undertaking renovations on a property you intend to sell or as bridging loan. You may also be able to claim higher tax deductions on an investment property.

What are the disadvantages of an interest only loan?

One of the more significant disadvantages is that you are not paying down the loan at all, so at the end of the interest-only period, you’re exactly where you started (depending on what you spent the loan money on, this may be outweighed by the value you’ve added to your overall portfolio or property.) Furthermore, market turndowns could reduce the value of your investment property during this time.

Interest-only loans can also attract higher rates on interest, so it is wise to seek independent advice about your specific circumstances – a financial adviser can help you model how various scenarios may play out. For example, how much you may pay in total on a one-year investment property project under an interest-only loan structure versus other types of loans which offer lower interest rates but may have repayments that hinder how much you can afford to borrow and payback – and therefore use to add value to your investment property.   

It’s also important to ensure you are able to make the higher repayment amounts if you do not sell the property before the end of the interest-free period.

What is an offset account?

Paired to an eligible home loan, an offset account works like everyday or savings account while saving money on your home loan interest.

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What are the terms of this loan?

An offset account is used as an everyday or savings account – you can set up your wages and other incoming money to sit in the account, and you can withdraw the money at any time. Any money in this account is offset against your loan, reducing the interest you pay. For example, say you have a $250, 000 mortgage, and there is $30, 000 sitting in your offset account. You will pay your home loan interest rate against $220, 000. So in a similar vein to the line of credit loan, by parking money in an offset account and only drawing out what you need for your investment property, you are minimising your interest to only the money you have used, not money that is available should you need it.

How long does the interest rate last for this loan?

As an offset account sits alongside your mortgage account, the interest rate remains the same as your mortgage – any balance in this account reduces the amount you are paying interest on, but the interest rate itself does not change.

Who is an offset account suitable for?

Offset accounts, borrowers with a mortgage account who have extra money to put into the account (you will routinely need tens of thousands sitting in the account to effectively reduce how much interest you’ll pay and benefit from this type of account.)

What are the advantages of this loan type?

Easy access to your money is a key benefit, as you don’t need to apply to access any funds in your offset account, as is the ability to bring down the total amount interest is payable on whenever a windfall (or just your wages) comes in.

There can also be tax benefits to storing your money in an offset account. The total saved in interest may be more than the interest you’d earn by putting it in a term deposit (which you are also often unable to access at will, or if you can, it may incur a hefty penalty) and the interest paid on your term deposit is a taxable income.

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What are the disadvantages of an offset account?

As with all things mortgage and finance-related, you’ll want to grab independent financial advice about your specific situation, and consider all the fine print – mortgages with offset accounts can attract higher interest rates (so if you know you’ll be using any funds in the account for your investment property, and effectively remove the benefits, you may find a different mortgage product with no offset facility offers better terms.)

What is a variable rate investment loan?

A home loan where payments increase or decrease in line with rises or falls in official cash rates.

What are the terms of this loan?

Variable home loans have an interest rate which fluctuates with the official cash rates – meaning your repayments will rise and fall over the term of the loan – by how much will depend on your lender.

How long does the interest rate last for this loan?

This is entirely dependent on the official cash rate and how much of any rise or fall your lender decides to pass on to their customers.

Who is a variable home loan suitable for?

Variable home loans suit those chasing a no or low frills loan with an indicative interest rate (it ebbs and flows with the official cash rate) and usually allow a borrower to make extra repayments without penalty. These types of loans can often work in conjunction with an offset account.

What are the advantages of a variable home loan?

Variable home loans allow you to take advantage of any drops in the official cash rate and pay any extra monies you may receive into the loan to pay it off quicker. While you may pay a slightly higher interest rate, you can often attach an offset account to this type of loan. These types of loans also tend to be more flexible, meaning they can be easier to break or change.

What are the disadvantages of a variable home loan?

The biggest disadvantage is your repayment amounts can fluctuate, which can be tricky on a tight budget.

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What is a Fixed-rate investment loan?

Much as it sounds, a fixed rate loan comes with a fixed interest rate.

What are the terms of a fixed-rate loan?

The fixed-rate period is set at the time of your contract – this can be months or years, and at the end of the fixed-rate period, the loan typically converts to a standard variable rate loan or you may be able to choose a new fixed-rate period and rate.

How long does the interest rate last for this loan?

This is determined by your lender, but typically won’t exceed five years.

Are you looking to purchase a property or refinance?

Who is a fixed-rate loan suitable for?

Fixed-rate loans are ideal for those with a set budget how do not intend to make extra repayments or end their loan before the end of the fixed-rate period.

What are the advantages of a fixed-rate loan?

The biggest advantage is being able to plan your repayments – the amount you repay will not vary during the fixed-rate period of your loan.

What are the disadvantages of a fixed-rate loan?

You will not be able to take advantage of any drops in interest rates for the period of your fixed rate, which can be disadvantageous during times with a fluctuating cash rate. These types of loans can also carry financial penalties – or fees – for breaking the loan during the fixed-rate period as it can cost your lender if you do so.

Muddling through the range of investment home loan products can be confusing – each has its own pros and cons. Speaking to one of eChoice’s independent brokers about your specific circumstances can help you find the right loan and lender fit for your circumstances. 

Words by: Melanie Hearse

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If you’re thinking of investing in another property, the brokers at eChoice are here to help! Contact us today and we’ll find you a competitive mortgage rate.

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