How to compare home loans and rates for investment properties

Property management

Buying an investment property is a good way to get on the property ladder and potentially profit from the investment. The first step towards buying investment properties is to compare home loans and rates. When you know where you stand, you can start looking for investment properties.

Rental property loans

Are rental property loans the same as normal home loans? They are similar, but there are differences you need to be aware of.

An important difference is the Loan-to-Value Ratio (LVR). When you purchase a home loan, you can get up to a 95 per cent LVR. When you purchase an investment property, you may only get an 80 per cent LVR. For example, if you purchase a home for $400,000, you may need only a $20,000 deposit. If it’s an investment property, you may need an $80,000 deposit. Some or all of that can come from the equity on your home.

Home Equity Loan on an investment property

Finding $80,000 to purchase a $400,000 property may be difficult for many investors, especially if you’re paying a mortgage on your home. You may already have the amount needed in the equity on your existing home.

If you’ve been paying mortgage on a home for a number of years, the value of the home has probably gone up substantially. If you paid $300,000 for a home, it may be worth $500,000 today. The $200,000 is the equity on your home. You may be able to take out a home equity loan to pay the deposit on an investment property. In most cases, you can take up to 80 per cent of the equity in your home to pay a deposit on an investment property. That’s up to $160,000 if you have a $200,000 equity.

Rather than jump into this option, study the costs involved. Aside from the purchase price of the investment property, you will also have to pay insurance, stamp duty, bank fees and other charges. These could add up to another $20,000.

Go to your existing lender first to ask about home equity loans. They will be anxious to keep you as a customer. If you switch lenders, you will have to pay an exit fee to your existing lender and an establishment fee to the new lender.

Exit fees can cost as little as $350, but can be as much as $700 to $1000 if you have only been paying a mortgage for a short time. In some cases, exit fees can be as high as 2 per cent of the loan cost. Establishment fees are usually between $500 and $1000.

Work out your cash flow before you take a home equity loan. You will be paying two mortgages and in some circumstances, the rent will not cover all the costs associated with an investment property. Other costs may include renovations, repairs, insurance and a property manager.

Many of the costs can be deducted from your income tax, but be sure you have enough cash flow to cover everything. For more information about costs you can deduct from your income taxes, read What can you claim back on an investment property at tax time?

Investment loan comparison

Interest rates can be substantially different. Monthly payments on a $300,000 loan at a rate of 3.91 per cent can be around $1800 per month. If the loan rate is 4.91 per cent, monthly payments can be approximately $1958 per month. It can be tempting to find the lowest monthly rate, but it can also be a mistake.

First of all, decide what type of loan you want. For investment purposes, you have a few choices. You can pay a variable rate that will fluctuate over time. You can pay a fixed rate, which will remain the same throughout the loan period. Another option some lenders offer is half variable and half fixed.

You can also find interest only loans. Some of these loans are capped at five years. Others can be as long as 15 years. If you take a five year interest only loan, you will have to switch to paying interest and principle in five years.

Also compare the way lenders calculate loan repayments. Some do so daily, which means you pay interest on your interest. Others calculate the rate on a monthly basis or according to your repayment schedule and you won’t be paying interest on interest.

Another way you may be able to pay a loan is with an offset account. An offset account calculates your interest on the amount you owe, rather than the full amount of the loan. If you pay a deposit of $50,000 on a $300,000 loan, with an offset account your balance is calculated on the amount due, $250,000. Even at a higher rate of interest, an offset account can save money in the long term and shorten the length of time it takes to repay the loan.

Lenders Mortgage Insurance

You may have to pay for Lenders Mortgage Insurance (LMI). It will depend on your financial circumstances or if a lender agrees to let you pay less than 80 per cent of the value of the investment property. LMI can be a one-off payment or may be added to your monthly payments. If you take the latter option, interest will be charged.

LMI protects the lender in case a borrower defaults on a loan. It is usually charged on higher risk loans. Larger banks usually provide their own LMI. Smaller lending institutions may have a private LMI provider. If one lender rejects your loan application because their LMI provider rejects your application, you can try a different lender, whose insurance provider may be willing to take a greater risk.

While it is possible to avoid LMI, it may not be advisable. For example, you may be able to find a guarantor, but the guarantor assumes the risk if you default on your property.

Some lenders offer a lower priced insurance. Called Reduced Equity Fee (REF), it can reduce the amount of insurance you have to take out. If an LMI costs $7000 on a $360,000 loan, an REF might cost only $4200.

Compare investment loans

Keep all these things in mind when comparing investment loan options. A low rate of interest may be calculated daily and you will pay interest on your interest. A higher rate may be calculated according to your payment schedule. While interest rates are low at the moment, consider how long you will be keeping the property. Interest charges may go up in the future. One way to hedge against that possibility is to negotiate a half variable and half fixed loan, which will help offset any interest rate hikes.

Consider all options available to you. Find a loan that suits your purposes and do your sums. In most cases, you will have an investment property for years. 20 tips for financing investment properties will help you understand the costs involved and how to find the right rental property.

Comparing investment loans is just half of the story. You will also have to find an affordable property in an area that offers a high rental return and has the potential to increase in value. Don’t overlook properties that need some cosmetic renovations. They can be good bargains and after renovations can fetch a higher rental rate. The best ways to maximise your rental return offers seven tips for getting the most out of investment properties.

Take your time and do all your sums. Compare investment loans and find a property that will pay dividends over time. If you do your homework, purchasing an investment property can be the best investment you can make.

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