If you already own a home outright or you’re comfortably paying off your existing first home mortgage, you might be considering purchasing an investment property. Unless you’re in the enviable position of being able to buy a property outright with existing capital, you’ll need an investment loan.
We’ve put together this guide to help make the best decision when choosing between the mortgages on offer.
First Tip: Look Beyond Interest Rates
Trying to find a competitive interest rate for your loan is important, of course – nobody wants to be paying higher interest rates than they have to. But it’s important not to become too myopic about this one factor. A range of other loan features can counterbalance a higher interest rate, or make a low interest rate less appealing on first look.
We’ll walk you through some of these features so you can take a more sophisticated approach to choosing your investment property mortgage.
Investment Loan Features and Options
The key factors to take into account before you decide on an investment loan are:
Fixed, Variable, or Split Interest
There are three options for interest rates on your mortgage: fixed or variable, or some combination of the two. The main advantage of a fixed interest rate is stability – if your interest rate is fixed at 5%, you know it will be that next week, next month, and next year. Fixed rates are best if you will need to be budgeting pretty tightly to make repayments, in which case it’s important for you to know in advance exactly what you’ll be paying.
There are downsides to a fixed rate, though. For one thing, if interest rates drop, you’ll still be stuck paying the same rate while everyone else saves. For another, variable interest loans offer a range of features that aren’t available with fixed rates.
Benefits of a Variable Interest Rate
Variable interest rates are generally lower than fixed rates, at least to start with. It’s important to note that they will change as economic conditions lead the Reserve Bank of Australia to adjust the cash rate. So, you might start with a rate of 4.25% but end up paying 4.75% a year later; or, hopefully, seeing your rate drop to 3.90%!
Many investors end up paying less overall with a fixed interest rate, but you need to have enough capital to weather rate rises and to leverage the additional loan features that a variable rate opens up for you, such as:
- Tax-deductible, interest-only repayments for a fixed period.
- Offset accounts – this option allows you to link a bank account to your mortgage, subtracting the amount in that account from your loan for the purpose of interest rate calculations. For example, if your loan is $425 000, but you have $50 000 in your offset account, you’ll only have to pay interest on $375 000! If you have enough money to maintain a significant chunk of cash in this account, you will significantly reduce your effective interest rate.
- A redraw facility to give you additional flexibility with your repayments. This feature allows you to make extra repayments on your loan while retaining the option to withdraw these funds if needed.
Best of Both Worlds
Many lenders provide the option to split your interest rate between fixed and variable options. This can provide more security than a fixed rate, but still grants you access to the features discussed above.
Don’t Forget About Fees
As well as the cost of repaying your principal loan and interest, it’s important that you factor in other fees. These may include application and/or discharge fees plus monthly or annual account keeping fees. There could also be fees for making additional repayments, opting for a rate lock, or breaking a loan term early.
Think Carefully About Loan Terms
Use a loan calculator to compare the amount of interest you will pay depending on the period of repayment. The shorter a period you can afford to pay your loan in, the better. You’ll pay more per month, but you could save tens of thousands in the long run by reducing the total interest owed.
Never overestimate how much you can pay each month just to save on interest, you need to be comfortably budgeted for whichever loan term you choose.
To learn more about which loan term may be the best option for you, contact us today.