Lenders generally have stricter criteria for assessing investment property applications. Although the policies of different lenders vary, they usually have a lower maximum loan-to-value ratio (LVR) that they’re prepared to accept for investment property loans.
What is an LVR?
An LVR for a home or investment property loan is the proportion of money you need to borrow expressed as a percentage of the value of the property you want to buy.
For example, if you want to buy an investment property valued at $700,000 and the lender assesses your level of equity in your own home as being $140,000, you’ll need to borrow an additional $560,000. Your LVR for the investment property would be 80% (i.e. $560,000 divided by $700,000).
Lenders typically have a lower maximum LVR ratio that they’re prepared to accept for investment property loans because they perceive them to be higher risk than residential home loans. This is especially the case if you’re going to be relying on rental income to generate the
cash flow.to help you make your investment property loan repayments. It’s important to remember that there’s always a risk that an investment property might not always be able to attract tenants, and your loan repayments will still have to be made if that happens.
If your investment property does become untenanted for any length of time, you’ll obviously be receiving no rental income during that period and you might be forced to drop the rent you charge to attract new tenants. For these reasons, lenders will generally discount the amount of rental income your investment property will potentially generate when they assess your loan application.
If you have an investment property application with an LVR above 80%, it’s likely that the lender will cover their increased risk by charging you one or both of the following:
- Lender’s mortgage insurance (LMI). LMI protects lenders if borrowers default on their repayments. It typically costs between 1-3% of the value of the loan. However, you this is an expense that you can claim as tax deduction on the rental income you receive from an investment property.
- A higher interest rate. It’s important to understand that even a small increase in the loan interest rate that you’re charged will make a significant difference to the amount of interest you’ll pay over the life of an investment property loan.
There are two ways to lower your LVR ratio:
- Provide a larger deposit (if that’s possible).
- Borrow less (i.e. buy a cheaper property). But if you do this, it’s still vital to choose a property that will be attractive to potential tenants.
What types of investment property loans are available?
There are different types of investment property loans available. Some may be better than others for your individual financial circumstances. For example, you can get:
- A standard principal and interest loan. This is where your repayments go toward both your interest and to reducing your principal (the amount you owe). This type of loan will help you increase your equity in the investment property as the principal reduces over time.
- An interest-only loan. These types of loans are typically offered for periods of 1 to 5 years. During the interest-only period, you’re only required to pay interest. That means your repayments are lower, so it can allow you to enter the investment property market sooner (or to buy a more expensive investment property than you could afford with a standard principal and interest loan).
But it’s important to understand that you won’t be reducing your debt during the interest-free period, so you won’t be increasing your equity as quickly as you would with a principal and interest loan.
It’s also important to understand that an interest-only loan will revert to a standard principal and interest loan after the interest-free period. To be approved for an interest-free loan, you’ll need to convince a lender of your ability to make the principal and interest loan repayments after the interest-free period expires.
- A loan with a fixed interest rate. Lenders typically offer borrowers the option of fixing their investment property loan interest rate for a period of 1 to 5 years. The advantage of fixing an interest rate is that it gives you certainty over your repayments during the fixed interest rate period. If interest rates rise, your repayments stay the same. This gives you peace of mind.
On the flip side, if interest rates fall, you’ll be stuck with your higher rate and higher repayments. But Australia’s interest rates are currently at record low levels and some financial analysts are tipping a rise sooner rather than later.
- A loan with a variable interest rate. As the name suggests, a variable interest rate loan can go up and down depending on market movements. There’s no certainty of your ongoing repayment amounts with a variable interest rate loan.
- A loan with a split rate. This is a loan where the amount you borrow is split into fixed and variable interest rate components. It allows you to hedge your bets on future interest rate movements because no one has a crystal ball to predict exactly which way they’ll move.
How we can help
At Fast Repay Home Loan, we can help you to implement strategies to pay off your home or investment property loan as soon as possible. We’ll take the time to understand your needs and goals so we can provide you with the best possible advice.
Call 1300 707 955 or email info@fastrepayhomeloan.com.au/backup to find out how we can help you, and secure your free consultation with a finance expert.
