Overview

If you are thinking about buying an investment property and have decided on your budget, the type of property and its location, all you need to do is arrange the right loan to suit you. There are a number of considerations including a wide variety of products and the structuring of your financial arrangements so as to fully achieve your investment goals.

Step 1: Consult your Accountant or Financial Adviser

Before applying for finance, it's critical that you take the time to check with your Accountant or Financial Adviser whether you are:

Purchasing the investment property in the correct name(s)
Arranging the investment loan in the correct name(s)
Offering the correct security property/properties for the loan
Holding the correct documentation for the Australian Taxation Office

This is important and is worth the expense (which is tax deductible anyway) to ensure that you're complying with the relevant legal and taxation regulations. Much difficulty can be avoided later by structuring your affairs correctly at the start!

Step 2: Loan Structuring

It's important to assess your present financial situation and the type of loan structure that best suits your needs. The first step will be to look at ways of raising a deposit (5% or 10% of the price) and the loan structures which are commonly used in financing an investment property.

Coming up with a deposit can be achieved by:

Saving sufficient money to pay cash (this may take years)
Borrowing against the equity in your current home
Arranging a Deposit Bond until settlement date

It's common for investors to borrow 100% of the purchase price plus the associated costs. This is often recommended by financial advisers because tax benefits are directly related to the borrowings i.e. when you maximise the borrowings you generally maximise the tax benefits. Of course, it's important you have sufficient income to handle the loans and other commitments. Lenders will usually require that you satisfactorily pass their Serviceability Assessment before the loan is approved.

To finance an investment property using the equity in the family home, you'll generally need to provide both the home and investment property as combined security for the loan/s. There are three common financing scenarios:

One loan: for both the home and investment property. You can obtain a single loan facility with different sub-account numbers - one for the family home and the other for the investment property. Tthere is no confusion over which tax-deductible portion of the facility relates to the investment property and which non-deductible portion relates to the family home.

Two loans: the existing home loan will remain in place and a new loan will facilitate the purchase of the investment property. Both loans will again have separate account numbers to ensure that the tax deductible and non-deductible loans are separate and easily recognised.

Three loans: one for each property and the third loan (perhaps a Line of Credit) which sits behind the loan on the family home and is only used to draw funds when needed to facilitate deposits on future investment properties. Usually, in this case (and in that of the two loan senario), the loans are arranged so that the total borrowings do not exceed 80% of the combined security values. This ensures that mortgage insurance is not payable.

The type of structure you choose largely depends on your personal preferences and how much the lender will charge you in fees for the set up. Of course, if you are to purchase an investment property without using a second property you'll only require a single loan. Loans up to 100% of the purchase price are available, but mortgage insurance will be payable.

Step 3: Types of loans

There are several types of loans available and within these loan types are a couple of fundamental options that you'll need to decide upon. These options include:

"Principal and Interest" or "Interest Only”

This choice is between having the loan balance reduce by making “principal and interest” repayments or having the loan balance remain the same by making “interest only” payments. Investors are usually advised to take an “interest only” loan, because principal reductions on an investment loan are not tax deductible. Therefore, the money that forms the principal component could be used to further invest in another tax advantageous purchase.

Fixed or Variable Interest Rates

This choice is about whether you are comfortable with your loan repayments fluctuating with market interest rate movements. Investors are often advised to select a fixed rate as this ensures a consistent monthly repayment amount, thereby allowing more certainty with budgeting.

These days fixed rate loans are not as restrictive as they once were. Many lenders allow principal payments to be made without penalty, although in most cases penalties still exist if you pay the entire loan during the fixed period. Also, most lenders now have the same interest rates for investors and owner-occupiers.

There are four basic types of loans that lenders offer for investment property purchases. Each lender has a specific name for its particular product and they all operate a little differently, but general speaking, you will find:

1 . “Principal and Interest” 20-30 Year Loan

This is your standard loan. You select the term and decide whether you'ld like a fixed or variable rate. Usually the fixed terms run from 1 to 5 years although some lenders now offer up to 10 years. You now also have the option of an initial “interest only” period of up to 10 years then reverting to “principal and interest” repayments for the balance of the agreed term.

2. Line of Credit Loan

With this type of loan the bank will approve a maximum loan amount against the property that secures the loan (generally 80% of the value). It operates like an overdraft and usually comes with a chequebook and card for easy access to funds. Generally these loans are “interest only” and have no specific term attached. This suits investors as they are often advised to get an “interest only” loan. They can be secured against the investment property or against the family home or both. They also have a high level of flexibility in that you can park spare funds into the loan account when they are available and draw them out again as required without notifying the bank, as long as you stay within your approved credit limit.

3. Multi Account Loan

This loan has a bit of everything and provides maximum flexibility It's set up with sub-accounts so that you can separate your different lending requirements and each sub-account can be tailored with the features you need. For example, account 1 is your home loan and is a “principal and interest” loan with a 3 year fixed rate. Account 2 could be $30,000 “interest only” Line of Credit on a variable interest and may be used for your share trading. Account 3 could also be an “interest only” Line of Credit used for an investment property deposit payments. The Multi Account Loan and the Line of Credit Loan usually have a higher interest rate than a standard amortising loan - a charge for the added flexibility and complexity.

4. Offset Account Loan

The Offset Account loan is generally used for residential property. It has a deposit account linked to the loan account. The benefit is that any surplus funds can be deposited into the linked account and the interest earned in this deposit account offsets the interest charged on the loan account. The effect this has is that the home loan is paid out faster because your standard monthly repayment has been calculated on the full amount outstanding. Offset Accounts generally offset 100% of the interest charged on the home loan, although the Offset Accounts offered by some lenders will only offset 50%, so you need to investigate this fully.

1. Make sure you discuss your plans with your Accountant and that you have the property purchase and loan application in the correct names.

2. Ensure you set up attractive loan facilities with loan amounts that are manageable. Insurance such as Income Protection and Landlord's Insurance are strongly recommended. Premiums for both are tax-deductible.

3. Search for a lower interest rate. Melbourne Mortgage Finance can assist you with this. A lower rate means lower payments.

4. Low fees…no one wants to pay high fees. Lenders sometimes offer “no fee” special deals which we can help you locate.

5. Consider an “interest only” option for an investment property.

6. Arrange flexible loan facilities which enable you to move quickly and easily should future purchase opportunities arise.