How Can I Finance an Investment Property in Australia?
Financing an investment property in Australia can be done in several ways. The main factors to consider are the deposit, the loan repayment plan and whether to use equity from properties you own. Financing an investment property will differ depending on whether you’re building or buying. You can leverage the equity of your existing properties to finance new properties.
What is an investment property?
An investment property is a home you own but do not use as a residence. Instead, it is used for financial gain in the form of rental yield or resale value. Investment properties are a popular method of wealth generation and provide lucrative tax benefits through deductions. However, investment properties have high up-front costs and are typically used for long-term financial gain.
Can I afford an investment property?
Whether you can afford an investment property depends on your financial situation and the cost of the property. To buy an investment property, you must be able to afford the deposit and pay stamp duty. You must also secure a loan and make loan repayments consistently. In addition, buying or building an investment property will affect costs – buying a property outright is usually a higher expense; building is typically cheaper but is a lengthier process.
A deposit is a lump sum of money you must pay upfront to secure a loan. A deposit effectively functions as security or collateral for the loan as well as the first loan payment. For a property loan, a deposit is a percentage of the property’s total value. The percentage itself varies. A deposit is the first step to securing a loan to pay for the rest of the property’s value.
Stamp duty is a type of tax paid for a range of legal transactions in Australia. These include property transfer, insurance policies, leases and mortgages, and hire purchase agreements. Stamp duty is calculated as a percentage of the property’s value which varies from state to state. The period you have to pay your stamp duty also varies by state. In some instances, you may be able to get an exemption from paying stamp duty, such as if you are a first homeowner.
A home loan has two parts: the loan principal and the interest. The loan principal is the amount of money borrowed from a lender. It is calculated by the difference between a property’s cost and the deposit paid.
Interest is how much the lender is charging you for the loan principal. You must repay the loan and the accrued interest over the agreed-upon period. There are different payment plans available for loans. Taking out a home loan results in a mortgage agreement between the lender and the borrower. If you have a mortgage, failing to repay loans may result in being served with a bankruptcy notice. This allows the lender to take the house you have borrowed money for as collateral.
Interest-only vs. principal and interest loan repayments
Your two options for loan repayments when buying an investment property are interest-only or principal and interest. Construction loans for building an investment property are interest-only. Interest-only is an arrangement where you only pay the interest you owe to the lender over a set period. Your principal will remain the same unless you make additional payments towards it during this period. Once your interest-only period ends, you must begin paying off your principal. In an interest-only repayment plan, less interest is paid during the loan period, but more interest is paid over the life of the loan. This is useful if low mortgage repayments suit your financial situation better for the near future. There are also tax benefits since interest accrued on the interest portion of the loan is tax deductible. With a principal and interest loan, you repay the principal and the interest concurrently. This results in higher payments but less interest paid over the loan term.
How do home loans work?
A home loan provides you with the total amount of money required to buy a home minus your deposit. You have the option between paying your home loan on an interest-only or principal and interest plan. Then, you set up a repayment plan with the bank or lender to retain ownership of your home.
How do construction loans work?
A construction loan works by covering expenses that occur throughout the building process. Construction loans function differently from home loans. Rather than receiving the whole loan at once, the bank provides the loan in instalments called progress payments or progressive drawdowns. Interest is only accrued on the money that has been drawn from the loan so far. Construction loans must utilise interest-only payment plans since the asset (the property) does not exist yet. This means there is an increased risk for the lender if problems occur during the building process. This also leads to construction loans requiring higher deposits. Once the building process is complete, the loan may switch to principal and interest payments.
How much is a deposit for an investment property in Australia?
The deposit on an investment property will be a percentage of the investment property’s value. The minimum deposit for a property will generally be 20% but can be as low as 10% in some cases. Paying a larger deposit allows you to borrow less money for the loan. Paying a lower deposit means having to borrow more for the loan and potentially having to get lenders’ mortgage insurance. Lender’s mortgage insurance is a type of insurance policy that protects lenders if borrowers cannot repay their home loans. Lenders’ mortgage insurance will be calculated as a percentage of the loan amount. It will vary depending on factors like property value, but it can be upwards of $10 000 or $20 000. So paying a larger deposit may work out cheaper when factoring in lenders’ insurance.
How to get an investment property loan
You can get an investment property loan from a bank or lender. Your ability to secure a loan will primarily be determined by your income, savings, credit rating and equity (if you already own a home). Additionally, using a guarantor helps boost your chances of securing a desirable loan.
Your income refers to the money you earn. Most often, this results from a wage or salary, but income can also come from alternate sources such as rental yield. Stable income and regular employment are often the first things a lender checks. They want to see that you have been employed for close to two years at the very least.
Your savings refers to the money you have accumulated in a savings account. This money comes from your income and is not used on weekly expenditures. Savings indicate to a lender you have cash in reserve that you can use to pay for unforeseen expenses. This makes them more secure so that you can complete your rental payments.
A credit rating is a score used to express an individual’s worthiness to receive a line of credit. A better credit rating indicates to a lender that the individual is more likely to repay the money they borrow reliably. Conversely, a low credit rating makes it very difficult to secure a loan. Credit ratings are increased by paying off bills on time and keeping your rate of credit utilisation low.
Equity refers to the value of an asset if it is liquidated and sold off. Regarding property investment, equity refers to the current market value of a property you own, subtracting the amount of your home loan that you have yet to repay. Equity increases over time as you gradually pay off your loan and your property’s value increases. Usable equity refers to the equity that you can access and borrow against. This is calculated by taking 80% of your property’s current value and subtracting what you still owe on your mortgage.
A guarantor is someone who cosigns your loan using their home equity. Essentially, a guarantor agrees to repay another person’s debt if said person cannot make their repayments. A guarantor is used to help someone secure a loan when they have less desirable financials. To be a guarantor for someone else’s loan, you must have a good credit history and demonstrate financial stability in your own right.
How to use equity to buy an investment property
If you already own a property, you can use the equity it has built up in place of a deposit to buy an investment property. The three main property investment strategies you can employ based on your equity are topping up an existing home loan, getting a supplementary loan or cross-collateralisation.
Top Up Existing Home Loan
One way to leverage your equity is to top up your home loan. Topping up your home loan refers to using the equity you have built up in your property to borrow money to fund something else. This increases your existing home loan debt and allows you to buy another property. You can increase your initial home loan by up to 80% of its initial value in some cases. Using equity to do this frees up the cash you would have had to use otherwise. In addition, this simplifies the process since you won’t need to apply for a new loan, and you only need to manage one set of repayments.
Equity can be used to set up a supplementary loan account. This allows you to include different features in your current home loan. For example, your supplementary loan may have a different term than your existing term. Additionally, supplementary loans will be other for residential properties compared to investment properties.
Cross-collateralisation uses your existing property’s equity as collateral and adds it to a new loan for purchasing a new property.
Typically, one property will secure one mortgage. Cross-collateralisation results in one original mortgage secured by the existing property and a new mortgage secured by both the existing and the new investment property. Both securities tied up in one loan may make them hard to separate in the future. Cross-collateralisation is an excellent way to build a property portfolio since it can lead to a better interest rate, tax benefits, and makes your portfolio easy to manage. However, it will make it more difficult to buy more property in the future.
Which grants are available for first home buyers in Western Australia?
In Western Australia, a first home buyers’ grant contributes up to $10 000 towards a home deposit. However, the first home buyers’ grant has limitations on which properties are eligible. These are based on the price and the location of the property.
To qualify for the WA first home buyers’ grant, you must:
Be over 18 years old.
Have a minimum of one applicant who is an Australian citizen or resident.
Have not received any other first home buyers’ grants or stamp duty exemptions.
Not previously owned a residential property.
Reside in the property for six months within the twelve months following the settlement or completion of the building.
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