If you are thinking about buying an investment property, you need to consider how you will finance it, i.e. an investment property mortgage. By all means look at the property market, see what properties are out there, but do not start negotiating the price, signing contracts or falling in love with a property without sorting out your finances first.
Yes, finance first, then property.
Below are some points to consider when you are ready to jump into investment property finance.
Why is it a good time to purchase an investment property?
The rental market has seen a dramatic shift in the last 12-18 months across Australia. As at March 2023, the rental vacancy rate in all capital cities was a historically low 1.43%. This is due to a combination of factors, namely higher interest rates and increased migration to Australia.
The 11 interest rate rises in the last 13 months has shifted the goals for a lot of people with respect to property. Many that were looking to purchase an owner-occupied property have chosen to put their plans on hold and to keep renting.
While higher interest rates are not preferred, the benefit of receiving rental income makes owning an investment property much more affordable. In the current market, this softens the blow of the higher rates. Additionally, as investment loan repayments are tax deductible, higher interest rates mean that the tax deductions are also increased for borrowers.
After the Covid lockdowns, we have seen an increased number of migrations to Australia, which has surpassed previous projections made. As a majority of these people are unable to purchase an owner-occupied property immediately (due to lending policy or personal circumstances), they will be looking for a rental property. This will further increase demand for rental properties.
Another reason to be optimistic about the property market is the increase in overseas investment. We have regularly seen the impact of such investment on property prices.
What makes property investment loans different to residential home loans?
Investment property mortgages are similar to residential home loans in many ways. However, there are some key differences between the two.
- Firstly, the majority of investment property mortgages are interest only, which means that only interest component is payable thus minimising monthly repayments.
- Secondly, when you have an investment loan, the interest repayments are all tax deductible.
This is another reason why investment loans are usually interest only, as the principal portion of the loan i.e. the part that is used to pay down the loan, is not tax deductible.
A great benefit of investment properties as well as the loans which secure them is that it is not only the interest repayments that are tax deductible. Most expenses associated with owning an investment property are tax deductible, including Lender’s Mortgage Insurance (a cost which is added to any loan which is over 80% of the value of the property) and any repairs or renovations. All of these items can assist in reduction of tax being paid at the end of each financial year.
Who qualifies investment property mortgages?
The criteria for qualifying for an investment loan is very similar to an owner occupied loan or any other loan. Lenders will review your income, assets, liabilities and expenses to calculate your capacity to service the loan.
The information which is usually reviewed by a lender is as follows:
- Payslips, PAYG Summary and bank statements confirming wages for employed applicants.
- Tax Returns and Financials for any self-employed applicants. Most lenders require the last 2 financial years, however there are some lenders that may accept just one.
- Bank statements confirming savings history as well as monthly expenses.
- Loan statements for any outstanding liabilities. This includes credit card statements.
As every situation is different, a lender may ask for additional information.
For single mothers buying property, most lenders will look at any Centrelink or Child Support payments which are received. Qualification will depend on the age of the children. The cut off is usually between 10 and 12 years of age.
If the deposit for the property is to be sourced from savings, the lender will need to see that the funds have been held in the account or saved over a period of at least 3 months.
If the deposit is to be sourced from equity in another property which you own, confirmation of ownership is required (Rates Notice) and a valuation of the property is conducted to confirm there is sufficient equity to fund the deposit.
How do you apply for an investment property mortgage?
Before signing a contract or making an offer on a property, it is vital to arrange pre-approval. This will ensure that you aware of how much you are able to borrow (and from there, what price range you should be looking at).
Having pre-approval is beneficial when speaking with real estate agents, as you will not be required to ask for a Subject to Finance clause. This may give you an advantage when negotiating for a better price with the seller.
There are benefits of using a Mortgage Broker when applying for a loan. Instead of meeting with each lender one-by-one, you are working with someone who has access to the majority of lenders in Australia and who is able to compare different loans and offer options to meet your personal circumstances. You will also be talking to one person throughout the whole process.
Once you provide the information mentioned in the previous section to the Broker, they will be able to calculate your borrowing capacity with numerous lenders. From there, they will provide you with a number of options based on your requirements and will submit an application for pre-approval to the lender of your choice.
Pre-approvals last for 90 days, which should be sufficient time to source the right property. Once a Contract of Sale is signed, it is submitted to the lender and the loan can proceed to Unconditional Approval.
It is important that during the pre-approval stage you do not make any significant changes to your financial circumstances, such as changing employment or taking out another loan without speaking to the Mortgage Broker or a lender first. Such changes may significantly change your borrowing capacity and you may not be able to qualify for the same loan amount. Your Mortgage Broker may have suggestion on when and how to go about making these changes.
Final words: Investment property mortgages
Getting an investment loan can be scary, especially for first time investors, but it does not need to be. Make sure you understand the process, you are comfortable with your Mortgage Broker or a banker and they have explained to you the loan structure and why they have recommended it.
Investing in property is a long-term process, so do not concern yourself with the amount of the loan, because today it may seem a lot, but in 5, 10 or 20 years you will probably be thinking that the properties at this time were not that expensive! The loan amount is a measure of the value of an asset you are acquiring and in the long term it will keep increasing.