Your goals and property strategy will determine the type of home loan you need.
When you’re comparing home loans, it’s easy to notice some distinctions between the products on offer, such as fixed rate versus variable rate or home loans packed with features versus no-frills products. But one of the most important distinctions is how you plan to use your home loan.
Home loans will vary substantially depending on whether you’re buying a property to live in or purchasing one as an investment.
In the past, there was very little difference between owner-occupier and investor home loan rates. Lenders tended to treat both classes of borrowers as equal risk. This is no longer the case.
In 2014, the Australian Prudential Regulation Authority (APRA), the body that regulates Australia’s banks, announced it would set a 10% cap on new investor lending. This meant banks had to reduce the proportion of new home loan business going to investors to 10% of their total home loans.
As a result of this change, lenders have tried to stem the tide of investment property borrowing, largely by lifting rates on property investment home loans. These days, there’s a significant gap between owner-occupier home loan rates and investor rates.
How significant? Currently, the lowest owner-occupier home loan rate on offer through the finder.com.au database is 3.54%. By contrast, the lowest investor rate on offer is 3.89%. This 35 basis point difference can make a big difference to the total cost of a loan.
Say you have a $500,000 home loan for 30 years at 3.54%:
- Monthly repayment = $2,256.40
- Total loan cost over 30 years = $812,304.90
But if the rate on that loan increased to 3.89% things would look very different:
- Monthly repayment = $2,355.48
- Total loan cost over 30 years = $847,971.87
- You'll end up paying $35,837.97 more
This being said, there are still attractive rates on offer for property investors, and some of the other features of investment home loans can help reduce the impact of higher rates.
Because of APRA’s clampdown on investment lending, many lenders have changed their criteria for property investors. This means the loans can be slightly more difficult to get than in the past.
Some lenders have changed the maximum loan-to-value ratio, or LVR, available to investors. LVR is the size of your home loan compared to the value of the property you’re buying. For instance, if you buy a property worth $500,000 with a home loan of $450,000, your LVR would be 90%.
Many lenders have reduced the maximum LVR they offer to investors to as low as 80%. This means you would need a 20% deposit to purchase a property. However, there are still lenders that offer property investment home loans with LVRs up to 95%.
In addition to changing LVRs, some lenders now require a more stringent examination of investors’ income and expenses. Some have wound back incentives available to property investors. And a few lenders have ceased lending to property investors altogether.
One of the main features commonly available to investors that is now rarely offered to owner-occupiers is interest-only repayments.
Repayments on a home loan are typically either principal and interest or interest-only. A principal and interest repayment means that a portion of every repayment is devoted to the interest while another portion is devoted toward the principal, or the original amount borrowed.
An interest-only repayment means that only the interest charges on the home loan are being repaid, so the amount you owe isn’t reduced. What is reduced, however, is the size of your monthly repayment.
For instance, if you had the 3.89% $500,000 investor home loan given in the example above, your principal and interest repayment of $2,355.48 would fall to $1,620.83 if you chose an interest-only repayment. This is a massive $734.65 difference in your monthly repayments.
While interest-only repayments used to be commonly available to both investors and owner-occupiers, fewer lenders are willing to offer these repayment terms. Investors can access interest-only repayments if they’re able to provide justification for the reason they’re choosing these repayments instead of principal and interest repayments. However, it’s rare these days for owner-occupiers to be able to justify interest-only repayments.
This is because interest-only repayments can put borrowers in a risky situation. Lenders who offer interest-only repayments do so for a pre-determined period of time, usually up to five years. At the end of this term, your home loan repayments would revert to principal and interest. This would mean a significant rise in your monthly repayments. Meanwhile, you would not have actually reduced the amount you owe.
So why would investors choose interest-only repayments? The answer is because of the different way investment home loans are treated for tax purposes.
Different tax treatment
Because investors are using their property as an income-producing asset, it means any income they see from their investment is taxed by the Australian Taxation Office (ATO). It also means they can deduct any expenses incurred while generating that income.
Because of this, investment property home loans are treated differently by the ATO than owner-occupier home loans. For tax purposes, the interest on an investment property home loan is seen as a business expense. Therefore, all interest payments can be deducted from the property owner’s income at tax time.
Interest for an owner-occupier home loan, on the other hand, is not deductible.
This tax treatment is why some property investors choose an interest-only home loan. Paying only the interest maximises their tax deductible debt while minimising their outgoings.
Summing it up
The way you use your property will ultimately dictate the type of home loan you need. If you’re a property investor, you may pay a bit more and need to save a bigger deposit in order to qualify for a home loan. However, with good rates still on offer and the favourable tax treatment given to property investors, putting your money in bricks and mortar can pay big dividends.
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