When does your owner occupier loan become an investment loan?
Renting out a room or turning your home into an investment property may be a smart financial decision. But do you have to tell your lender that you're making money from your home – and will this cost you more?
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When you decide to move out of your home, whether it's to upgrade to a bigger property, downgrade to something that requires less maintenance, or simply move into a more suitable space, you may consider keeping your existing home and renting it out.
Alternatively, if your home has a bedroom that has become a storage dumping ground, or you have a granny flat that isn't occupied, you might be planning to maximise your finances by renting out part of your home.
In either of the above scenarios, you are repaying your existing owner-occupier mortgage as a homeowner, however the property is now producing an income – and this may change your obligations with your lender, not to mention, it brings up a raft of tax considerations.
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But mortgage broker Andrew Mirams, managing director at Intuitive Finance, says that in the last decade, regulators like APRA and ASIC have intervened. They imposed strict guidelines and restrictions on lenders in order to force them to limit their exposure to investment loans, which means lenders are now required to grade investment loans differently.
As a result, investment loans can be more expensive than owner occupier mortgages.
"In days gone past, a home loan and investment loan was basically the same rate, so it really didn't matter. Now, you pay a premium for an investment loan, meaning your repayments will be higher than you would pay on your own home loan. And who wants to pay more?" Mirams says.
"Most people don't update their lender and say, hey, I've changed my living situation, it's now an investment property and I'd like to give the bank an extra 5 grand or 10 grand a year. No one is doing that!"
No one may be lining up to give the bank more money. But are they legally required to do so?
What happens to your loan when you rent out a room?
The lender will usually require the mortgage holder to change the status of their loan in the event that the property stops being their primary residence.
However, let's say you own a two-bedroom apartment and you decide to rent out one room to a friend or colleague.
MyState Bank general manager, banking, Tony MacRae, says that in this instance, you don't need to inform your lender.
This is because by definition, your owner occupier property is still recognised as your primary residence, as you remain the owner occupier.
"Regardless of whether you're renting out one bedroom worth 30% of the home's overall footprint, or two bedrooms worth 60%, the loan is still classified as an 'owner occupier' if you're renting out a portion of the property while it remains your primary residence," MacRae explains.
"From a lender's view, this scenario doesn't impact the status of the loan. While a mortgage holder is using the property as their primary residence, the loan remains an owner occupier – not an investment loan."
MacRae says that a borrower who is renting out a spare room is therefore not required to let their bank know, as long as the property remains their principal place of residence.
"However, if you're planning to earn a rental income and have to make structural changes to the property such as adding a spare bedroom, you may have to have a conversation with your bank," he says.
He adds that it's strongly recommended that you speak to your insurance company about any change to your living arrangements, as inviting paying renters into the space could impact your house and contents insurance policy.
What happens to your loan when you rent out the entire property?
Mirams points out that as a borrower, you have one primary obligation: to make your loan repayments.
"If you move out of your home and you rent it out, your primary obligation with the lender is still to make the repayments. But in the terms and conditions of your loan contract, it states that you're obliged to tell your lender if your circumstances change," he says.
It's unlikely that a lender would require or compel you to change the loan product, such as moving it from interest only to principal and interest (or vice versa).
However, MacRae confirms that the lender will usually require the mortgage holder to change the status of their loan "in the instance that the property stops being their primary residence".
"For instance, as a borrower, if you continue to rent out the property but move out and live elsewhere, you will have to inform the bank, which will potentially change the status of your loan, as well as interest rates and repayment amounts," he says.
What else do homeowners need to consider before renting out their home?
There may be tax implications – both positive and negative – if you're planning to rent out a bedroom or two and earn extra income, so it is best to speak with your accountant about how this would affect you before you turn your home into an investment property.
Peter Locandro, managing partner at Chan & Naylor in Victoria, says that once your owner occupier loan becomes an investment loan, there are some points of interest from the ATO's perspective.
"If you rent out all or part of your home, the rent money you receive is generally regarded as assessable income. This means you must declare your rental income in your income tax return; you can claim deductions for the associated expenses, such as part or all of the interest on your home loan; and you may not be entitled to the full main residence exemption from capital gains tax (CGT), meaning you'll have to pay CGT on part of any capital gain made when you sell your home," he explains.
"Goods and services tax (GST) doesn't apply to residential rentals, so you're not liable for GST on the rent you charge. You also can't claim GST credits for associated costs."
The types of tax deductions that are available to a homeowner if they rent out part or all of their home may include:
- Mortgage interest
- Strata fees
- Council and water rates
- Building insurance
- Repairs and maintenance (related to the space you are renting out)
- Advertising for tenants
- Pest control
- Bank fees
- Land tax
If you are only renting part of your home, for example a single room, you can only claim expenses related to renting out that part of the house. This means you can't claim the total amount of the expenses you incur – you need to apportion the expenses.
"As a general guide, you should apportion expenses on a floor-area basis based on the area solely occupied by the renter or user, and add that to a reasonable amount based on their access to common areas," Locandro says.
"You can only claim a deduction for expenses when the room was rented to a client. If you use the room in any capacity when it's not occupied, for example for storage or as an office, you can't claim deductions."
Renting a room to a friend or family member
Another point to consider is how much rent you charge. If you rent out all or part of your home at less than normal commercial rates – for example, you rent to a relative or friend at a reduced rate – this may limit the deductions you can claim, Locandro says.
"Note that payments from a family member for board or lodging are considered to be domestic arrangements and are not rental income, so you can't claim deductions for expenses in these circumstances," he advises.
Finally, there are some Capital Gains Tax (CGT) implications homeowners should be aware of.
"Generally, you don't pay CGT if you sell the home you live in under the main residence exemption," Locandro says.
"However, if you've used any part of your home to produce income – for example, by renting out all or part of it – you're generally not entitled to the full exemption. To work out the capital gain that is not exempt, you need to take into account a number of factors, including the proportion of the floor area that is set aside to produce income; the period you use it for this purpose; whether you're eligible for the 'absence' rule; and whether it was first used to produce income after 20 August 1996."
Due to the complexities and tax law involved, it's recommended that you seek advice from a qualified accountant before you rent out a room or your entire property, to ensure you're maximising your tax deductions, and you're not inadvertently wracking up a big tax debt in the form of CGT.
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