After months of researching and investigating, you have finally made the decision to purchase an investment property. You’ve looked at suburbs and found the perfect property and feel like you’re ready to take the next step – apply for finance.
Author: Don Crellin, General Manager, Resolve Finance.
Have you stopped and thought about what type of loan product would best be suited to your individual needs?
Banks and lenders are not too different from department stores – they all offer similar products which may look comparable but it’s not until you look closely at the details that you realise what might be a perfect product for one person may be completely inappropriate for the next.
As with anything related to property investment, the key is to research and clearly understand the loan structure before signing anything. To help get the process started, the eight main types of loans are briefly outlined:
- Standard variable rate
- Fixed rate
- Basic variable rate
- No deposit or low deposit loan
- Line of credit equity loan
- Combination/split loan
- Low documentation loan
- Non-conforming loan
1. Standard variable rate
This is one of the most popular home loans on offer. This loan allows you to inject more money into it, so you can pay off your principal sooner and reduce your interest repayments. It’s also easier to switch loans, lock in a fixed rate and refinance. As the variable rates are set with reference to the Reserve Bank of Australia’s (RBA) official cash rates, you could see a lot of fluctuation throughout the life of this loan.
Pros: Standard variable home loan rates offer you flexibility with a range of optional features such as a redraw facility, offset account, extra repayments or access to a line of credit which can help you to reduce the term and cost of your loan.
Cons: The interest rate with a standard variable home loan is generally higher than a basic variable home loan rate. Also, banks may not pass on the savings when the RBA lowers their official cash rate.
2. Fixed rate
Suited to those who want to know what their repayments are each month, this loan lets you lock in an interest rate for a specified term, whether it’s six months or ten years. At the end of this term, the loan reverts back to a standard variable rate.
Pros: You know exactly what your monthly repayments are, regardless of the fluctuating market. If the RBA increases rates consecutively over a period of time, it could surpass your fixed rate and leave you with lower monthly repayments than those on a standard variable rate loan.
Cons: You will be locked into the loan for a set amount of time and if you decide to pay out the loan before the fixed term, your exit fees and ‘break costs’ could be quite high. Trying to lock in a rate that beats the market is like taking a gamble – there’s no perfect time to do it and no guarantees it will pay off. Just try and concentrate on securing a rate that is affordable for you throughout the fixed term.
3. Basic variable rate
Suited to any borrower who is looking for a ‘no frills’ loan solution with a lower variable rate, this product offers less ‘bells and whistles’ than a standard variable loan. That is, the basic variable rate loan will not offer you a complete package such as an everyday savings account, credit card, offset account etc.
Pros: These loans generally have a lower interest rate (sometimes as much as 0.5 per cent per annum) as they don’t come with any fancy features.
Cons: Basic variable cash rates can vary with the RBA rate movements depending on the RBA’s official cash rate. There’s also limited flexibility with a basic variable loan.
4. No deposit or low deposit loan
Suited to those with no or a low deposit, this loan is best for borrowers with a good income but who lack a full deposit. Loans that offer 95 or 100 per cent of the required amount do exist but are very tough to secure. Any loan that offers 80 per cent or more carries the additional cost of Lenders Mortgage Insurance but is worth the expense if it means gaining your property sooner. You can also use the equity in a relative’s home to cover your deposit in a family pledge loan.
Pros: For those struggling to save a five or ten per cent deposit, using family equity may help you secure your home loan.
Cons: These loans can be high risk, particularly if a family member is putting up their property as equity. Make sure all parties understand the risks involved and seek independent legal advice before committing.
5. Line of credit equity loans
With a line of credit home loan, you can access the equity in your home and use it for things like renovations, investments or other personal purchases. It’s a bit like having a credit card with a big limit, but your home acts as security for the loan.
Pros: You only pay interest on what you use. Although you have access to all the equity in your home, you only pay interest on the funds you draw down.
Cons: You have to be disciplined. You need to make sure you pay off the principle as well as the interest, so that your loan reduces over time.
6. Combination/split loans
Suited to borrowers looking to spread rate risk, this style of loan splits the total amount you are borrowing between different products – usually a fixed and variable interest rate loan. Your mortgage broker can advise of the best way to tailor the split.
Pros: You can lock in a fixed interest rate for part of the loan amount, while the variable rate portion of the loan leaves you with flexibility to make extra payments and redraws.
Cons: Make sure a mortgage broker has tailored the combination loan to suit your specific needs. Also beware of the ’break costs’ of the fixed term part if you wish to refinance or switch to a different structure.
7. Low documentation (Low Doc) loans
Suited to borrowers who are self-employed, this product requires less supporting documentation to confirm income. Low Doc loans can have fixed or variable rates and are ideal for those who are not eligible for a conventional home loan. Although proof of regular income may be difficult to prove, lenders view the self employed as ideal candidates due to their business cash flow.
Pros: Low Doc borrowers can generally borrow up to 80 per cent of the property value.
Cons: The more you borrow, the higher the risk and this will usually lead banks to demand Lenders Mortgage Insurance is included. Interest rates can also be higher than full doc loans and the eligibility criteria is usually very strict.
8. Non-conforming loans
Suited to credit impaired, self-employed, non-residents, new residents and no deposit borrowers, this loan is best for those who are unable to obtain credit from a traditional lender. Rates for non-conforming lenders are typically higher than those for banks but terms are more flexible and loans are more easily attainable.
Pros: These loans are now a lot more flexible than they were in the past and may be available as a variable, split or fixed rate loan and may include features of a traditional loan.
Cons: Interest rates are generally higher and so are the fees.
Additional finance considerations
Property investors should also discuss the following strategies with their accountant prior to making a decision to purchase an investment property:
- Interest in advance - this is a loan that increases the overall tax deduction by allowing the investor to pay the following 12 months interest in this financial year.
- Self-Managed Super Fund (SMSF) – assess the tax concessions involved in investing in property via a Self-Managed Super Fund.
- PAYG variation – this involves applying to the ATO to reduce the amount of tax withheld from your regular salary, increasing your take home pay which can then be put towards the ongoing cost of repaying your home loan. This can improve cashflow where you have a negatively geared property that will make a loss.
If you are considering different home loans and want to see how they compare, view the various online resource calculators which are available on the Resolve Finance website and enable you to compare two different loans or view what impact it will have on your loan if you decide to pay off more than you need to each month, make a lump sum payment, reduce the payment term or exit your loan early.
With so many lenders and products to consider, navigating the best deal for you can be difficult without expert advice. However, a qualified mortgage broker, such as Resolve Finance, can help you choose which lender and product best suits your needs.
Resolve are an award winning brokerage with over 14 years’ experience in helping property investors set up and secure the right loan for their situation. As number 9 in The Advisor magazines Top 25 Brokerages, they know precisely what’s needed and when, and can coordinate it all for you. For more information on this topic please visit Resolve Finance at www.resolvefinance.com.au.
DISCLAIMER: This information is of a general nature only and does not constitute professional advice. We strongly recommend that you seek your own professional advice in relation to your particular circumstances.