What Is the Right Loan Structure for Your Investment Property?
Making the decision to invest in property is a positive step towards strengthening your financial future. It’s likely you’ve spent time researching the location and rental demand in your chosen location, as well as inspected a number of different properties before making the decision about which one to purchase.
Yet it’s also equally as important to ensure you do some research into the right loan structure for your investment. A poorly structured portfolio may reduce flexibility and lower your ability to manage risk effectively. The loan structure you choose could be the key to maximising your cash flow and helping you achieve your financial goals.
Here are some things to consider when determining the right loan structure for your investment property.
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Fixed or variable interest rate
One of the first things to consider is whether you want a fixed or variable interest rate for your investment mortgage. A variable rate is often cheaper than the fixed rates available and can provide more flexibility. For example, a variable rate home loan may allow you to make extra repayments without penalty, access additional funds in the redraw facility, or link a 100% offset account to the mortgage to reduce the interest you pay.
By comparison, choosing a fixed rate means your repayments won’t change throughout the fixed rate term. Choosing a fixed interest rate reduces any concerns about payment fluctuations throughout the fixed term, which can make it easier to manage cash flow for some investors.
Interest only or principal and interest
When you set up your investment mortgage, you’ll be asked whether you want your repayments calculated as ‘principal and interest’ payments or interest only. When you make principal and interest payments, one portion of every repayment covers the interest charges due and the remaining portion pays down your balance a little.
Interest only payments allow you to pay only the interest charges due on your balance each month. Your payments don’t reduce your balance at all.
Keep in mind that only the interest component of your mortgage payment is tax deductible. For this reason, many property investors set their investment mortgages to interest only payments.
Deposit or equity
Some property investors choose to use the equity they’ve built up in the family home as security for the purchase on an investment property. Essentially, the bank uses the equity in the family home as collateral against borrowing the full amount of purchase costs and fees associated with buying the investment.
For example, let’s say your family home is valued at $500,000 and you have an outstanding mortgage of $150,000. You decide to buy an investment property valued at $350,000 and your stamp duty and fees come to $17,500. The bank combines the value of both properties, so they see $850,000 worth of real estate. Then they add together the total debts, so they see $150,000 for your home loan plus $367,500 for your investment mortgage.
If you choose to use your equity as security for the purchase, the bank may allow you to borrow the full amount of the purchase price, plus the cost of the fees on your investment loan. However, they take both properties as security over each other as collateral for both loans. This is known as ‘cross-collateralisation’.
By comparison, you have the option of applying for a separate mortgage over your family home that unlocks some of your available equity. The amount of unlocked equity is put towards a deposit on the purchase of your investment property.
The benefit of using a separate loan amount to provide the equity needed is that you aren’t locked into cross-collateralising your properties. Each property is only securing its own debt, so you aren’t risking more than one asset if something goes wrong.
You also have the freedom to spread your loans across more than one bank. Some property investors may find that cross-collateralising their properties can potentially limit their ability to continue growing their investment portfolio over time.
Choosing the right loan structure for you
When it’s time to choose a loan structure for your investment, take time to discuss your options with an experienced home loan consultant. What might work well for one investor may not be suitable for another, so it’s important to tailor your own loan structure to suit your financial situation and your personal financial goals.
This article provides general information which is current as at the time of production. The information contained in this communication does not constitute advice and should not be relied upon as such as it does not take into account your personal circumstances or needs. Professional advice should be sought prior to any action being taken in reliance on any of the information.