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Investment loans versus owner-occupier home loans
Investment loans and owner-occupier loans are similar, but not identical, and choosing the wrong type of loan can cost you more in the long run. Here's how to find the right loan for you.
Investment Finance Guides
Strategy + Advice
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This article was fact-checked and reviewed by Cam McLellan, a property investment specialist whose book, My four-year-old the property investor, has sold more than 100,000 copies. Content has been updated for 2021.
You may think comparing loans for a rental property is just like getting a mortgage for your own home, but it's quite a different process. From the outset when you’re comparing home loans, there are different aspects to consider, including interest rates, product selection and the bank's attitude and policies towards investors.
The specific interest rates you pay and the way a bank or lender assesses your application will vary substantially, depending on whether you’re buying a property to live in or purchasing one as an investment. Regardless of the purpose of the loan, you can usually get a fixed rate or variable rate home loan, and you can choose to pay for a mortgage packed with features or a no-frills product. Here's how to decide which is the right option for you.
A brief recent history of interest rates
After the GFC, the government used the term "unquestionably strong" when instructing Australian Prudential Regulation Authority (APRA), the body that regulates Australia's banks, to exercise their power to ensure our finance sector could ride through any future local or global disaster.
Cam McLellan is a property investment specialist, the co-CEO of OpenCorp, and the bestselling author of "My four-year-old the property investor".
What we saw in 2013-2017 wasn't unusual, given the market cycle. Sydney's median house price rose 75%, and in 2014-2018 Melbourne's median house price rose 59%. What happened next was a test of APRA's power over the market. It showed it could pull its levers to ensure our property markets maintained safe, consistent growth.
By February 2017: APRA was alarmed that 60% of Sydney property purchases were interest-only investment loans. This meant 60% of properties in Australia's most expensive market, at the end of a major growth phase, were being bought by speculators trying to get rich quick. The banks had to slow this down. APRA realised that too many investors were trying to buy at the end of a market growth period (and were potentially about to lose money when a correction occurred). So, they put measures in place to protect investors from buying in an overheated market.
APRA brought the sledgehammer down on Sydney speculation. It introduced major restrictions on lending to investors, which caused a massive reduction in borrowers who qualified for lending, which led to a slowdown in demand for housing. Sydney and Melbourne median house prices reduced accordingly. This was an expected market correction after the high growth.
By October 2017: APRA had instructed banks to reduce their proportion of interest-only loans to 30% by 31 October. The banks had to move fast to accommodate this, so they introduced massive incentives for borrowers to move from interest-only to principal and interest loans.
The biggest "carrot" was an interest rate difference of around 1% per year between the two loan types. Savvy investors weren't put off by this. Interest is tax deductible, and the favourable cash flow of interest-only loans still made sense. But most Australians are taught to think about favourable lending products by interest rates only. APRA's move had the desired effect and almost every bank hit its October deadline.
By December 2018: With the 30% cap achieved, APRA knew its levers had worked. It removed the cap and the market started to loosen. Prices started to rise due to genuine pent-up demand, rather than speculation. APRA had done its job.
Now that the government and APRA are confident that they have the levers to use when required, they are confident that our financial industry is "unquestionably strong". This being the case, post-COVID, there will be further loosening on lending requirements, which will mean people will be able to access larger amounts of debt with more ease.
Interest rates from 2019 onwards
In the past, there was very little difference between owner-occupier and investor home loan interest rates. Lenders tended to treat both classes of borrowers as equal risk, but this is no longer the case. These days, there’s a significant gap between owner-occupier home loan rates and investor rates, though it's not as wide as it was during APRA's interference.
In the graph below you can view the lowest rates for fixed and variable investor and owner-occupier home loans in our database.
You can see from this data that there is usually a 30-60 basis point gap between investor and owner-occupier rates. A difference of 0.60% can have a massive impact on mortgage repayments. Here's an example:
Say you have a $500,000 home loan for 30 years at 3.0%:
- Monthly repayment = $2,108
- Total loan cost over 30 years = $758,887
But if the rate on that loan decreased to 2.4%, your repayments become much lower:
- Monthly repayment = $1,941
- Total loan cost over 30 years = $701,894
- You'll end up paying $56,993 less
Is it harder to get an investment loan now?
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 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. Since APRA restrictions began loosening, more lenders started offering property investment home loans with LVRs up to 90% and sometimes even 95%.
In addition to changing LVRs, some lenders now require a more stringent examination of investors’ income and expenses. Others have different policies that can impact investors: for instance, bank A might take into consideration 100% of the rental income your rental property generates, but bank B only counts 80% of the rental income when assessing whether you can afford the loan.
What features should you look for in an investment loan?
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. However, what is reduced is the size of your monthly repayment.
For instance, if you had a $500,000 investor home loan with an interest rate of 3%, your principal and interest repayment of $2,108 would fall to just $1,250 if you chose an interest-only repayment. This is a massive $858 difference in your monthly repayments – over $10,000 per year.
Compare interest-only home loans
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 that offer interest-only repayments do so for a pre-determined period of time, usually up to five years. At the end of this term, the home loan repayments would revert to principal and interest. This would mean a significant rise in the 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.
Consider the tax treatment of your loan
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.
Maximising your tax return as an investor
Which is the right loan for you?
The way you use your property will ultimately dictate the type of home loan you need. As a property investor, you may pay a higher interest rate or jump through a few more hoops to get your loan approved. However, with very competitive rates 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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