Choosing a loan for an investment property

November 15, 2017
Melinda Halloran

When it comes to growing your wealth, property is one of the most popular forms of investment in Australia. Our robust property market offers peace of mind for investors, and choosing the right loan will help you to maximise the returns on your investment property.

Ready to invest in property? This is one of the most accessible forms of investment, as your investment loan will cover up to 90% of the purchase cost. And if you already have equity in your home, you may not need to save a deposit in order to purchase the property.

The loan you choose to purchase your investment property should tie in with your strategy. With the right loan, you can manage your cash flow and work towards maximising the returns on your property. And that’s the really exciting part of property investment. 

Before we get your loan options, let’s look at the two types of returns you will get from your investment property. The type of return you are looking for will determine your strategy and which loan is right for you. 

Investment property returns

Rental yield

The yield from your investment property is the income you make on your property. You can request yield data from your agent or calculate it yourself. Here’s a quick maths lesson for you.

You can calculate the total rental yield using the following formula: 

Gross rental yield = (Annual rental income / Property value) x 100

So if you purchase a property for $390,000 and it returns a weekly rent of $500, you would have a rental yield of 6.67%.

A more accurate indication is to work out the net rental yield, which is the profit after all expenses have been accounted for. The formula for this is as follows: 

Net rental yield = [(Annual rental income – Annual expenses) / Total property cost] x 100

Let’s use the same example of a property purchased for $390,000 with a weekly rental income of $500. If property’s total cost of purchase was $430,000 and the annual expenses are $4,500, the net rental yield comes in at 5%.

These calculations are helpful when determining how profitable a rental property is likely to be.

Who is a rental yield strategy for?

A focus on gaining rental yields is suited to investors who don’t want to borrow heavily, or who want an additional source of income to live on (though be mindful of the tax you need to pay on properties that are positively geared).

Related: What is negative gearing?

Capital growth

Capital growth is the increase in a property’s value over time. This is an important metric if you wish to purchase an investment property to sell at a profit in the future.

The other benefit of capital growth is that your savings remain in sync with inflation. For example, if kept $500,000 in a savings account, your money would earn interest but the purchasing power of your initial $500,000 would decline over time. Purchasing an invest property, however, preserves the purchasing power of your savings while also making you income through rent or capital gains.

Who is a capital growth strategy for?

A capital growth strategy is for investors who are prepared to hold on to the property for some time. It may take several years for you to see growth in the value of your property, so you need to ensure you can maintain the loan for an extended period.

Note: Both of these strategies are linked and in many cases, you will more than likely make income from both rent and capital growth. However, there are some investors who may prioritise one income stream over the other, depending upon their plan. Speaking to a financial planner will help you to work out what’s best for you.

Investment property loans

There are three main types of loans for property investment. 

1. Standard variable and fixed rate loans

If you already have a mortgage, you will be familiar with these loans. The interest rates on variable rate loans do fluctuate, however they offer more features and flexibility. 

A fixed-rate loan, on the other hand, gives you the certainty of fixed repayments. The added advantage of this is that you can prepay up to 12 months of interest, which can be claimed as a tax deduction. This is offset against your income and can be used in years when your income may be higher than normal. 

Who is this loan for? 

These loans work the same way as a standard home loan in terms of repayments. Fixed-rate home loans have some tax advantages for property investors who may have fluctuating income streams they need to offset, such as contractors or those with other forms of investment.

These loans work for investors who are seeking both capital growth and rental yield. With regards to rental yield, the term of the loan and the way you structure your repayments can help with the gearing of the property, depending on whether you prefer negative or positive gearing.

2. Interest-only loan

As the name suggests, an interest-only loan allows you to repay only the interest on the loan. With this type of loan, you only need to pay the principal (the amount you borrowed) when the property is sold or when you revert to a different loan. 

Interest-only loans appeal to investors, as the repayments are lower and all the repayments are tax deductible, as principal repayments do not count as a deduction. It is important to note that these loans have a term of up to five years, after which you need to renegotiate your loan with your lender.  

Who is this loan for? 

This loan is best suited to investors with a capital gains strategy, who do not have any plans to ever own the property outright. Be mindful that after the term of the loan is up, you may need to switch to a principal and interest loan. This means your repayments will increase and you should ensure that you have the capacity to make the extra repayments. 

3. Line of credit

A line of credit loan allows you to use cash from your loan (up to a certain limit) as you need it. These funds act like equity and can be used for a variety of things, such as a deposit for another investment property. This type of loan does not have any set repayments.

Who is this loan for?

This type of loan is best suited to experienced investors or those who can manage their money carefully. 

Want more information about purchasing an investment property? Download our investment property guide for extra tips including purchase costs and how to make a solid financial plan. – Trevor

Related: Should you invest in property interstate? 

 

Posted in: Property investment

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