These days, people have loans for a whole range of things – including homes, cars, education, and much more. Servicing all of these loans at once means that many people tend to “set and forget”, thus as their individual circumstances change they can end up with loans that no longer work for them. This is very true for people with investment properties given the change in lending guidelines for investment property borrowers. The trouble often lies with being able to take the time to look at each loan individually and determine where improvements can be made; or even having the knowledge and experience in the first place to work out any issues. This applies to people with existing investment loans and those looking to get into the market. The following are some things to consider when evaluating your home loans:
Interest Only (IO) vs Principal & Interest (P&I)
When setting up an investment mortgage, you’ll generally be offered an Interest Only (IO) or Principal & Interest (P&I) repayment option. With P&I loans, each repayment you make covers the interest charges due, as well as chip away at your balance. Generally, this option is beneficial if you want to pay down the mortgage and use the equity to purchase another property. Conversely, interest-only payments allow you to pay only the interest due each month, and not the balance. This results in lower payments each month, which can be great for cash flow and to maximise the tax benefits of property investment (as only the interest portion of a loan is tax-deductible). Note, due to APRA changes introduced in 2017 clients considering IO repayment option must understand that - IO repayments will not reduce the principal of the loan during the IO period, the repayments to pay out the loan will increase after the IO period ends to cover P&I repayments, the applicants are likely to pay more over the life of the loan if there was no IO period and rates for IO loans are generally higher than P&I loans. (This feature of an Investment loan is strongly recommended to be discussed with your Accountant or Financial Adviser).
Fixed vs Variable Interest Rates
Another important consideration when evaluating your home loan is determining whether or not a fixed or variable interest rate is right for you. A fixed interest rate means the repayments won’t change and allow you to budget for a fixed term which may reduce concerns about payment fluctuations throughout the term of the loan. On the other hand, Variable interest rates can provide greater flexibility. This could come in the form of the ability to make extra repayments or pay the loan out in full without penalty, link a 100% offset account to the mortgage to reduce the interest you pay, or leverage redraw facilities. Note Fixed rates may have potential additional risks such as break costs if you choose to repay the loan in full or make additional repayments greater than those allowed by the Lender.
Deposit vs Equity
A common way for people to get into property investment is to use the equity in their family home as security for the purchase of another property. In these situations, the bank may let you borrow the full amount of the purchase price, plus the cost of the fees on the investment loan. Both properties, however, are taken as security over each other (“cross-collateralisation”). Comparatively, you could apply for a separate mortgage over your family home that unlocks some available equity, which can then be put towards a deposit on the purchase of an investment property. The benefit of a separate loan is that you aren’t locked into cross-collateralising your properties. Each property secures its own debt, so you don’t have to risk more than one asset if something goes wrong. Another benefit of a separate loan is the freedom to spread loans across more than one bank, thus affording you the potential to hunt for the best deal and perhaps even grow your portfolio a bit faster.
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