Structuring Investment Property Loans

Structuring Investment Property Loans

More and more people are investing in rental properties these days. Whether to create a passive income stream or just because of the potential capital gains, everyone wants to get started with some good advice.

The problem that often pops up is that you need money for this kind of thing. When you do not have any cash savings, then what does one do? The solution may be an investment property loan.

What is an Investment Property Loan?

An investment property is rented out to someone else while the owner lives in it or receives rental income while using their own money for other purposes.

This can include buying another house or perhaps taking a vacation, but essentially any purpose where the person needs some extra cash to get back what they spent plus interest over time (or get their money back).

The purpose of the loan is to provide the person with a steady flow of cash that can be used for other purposes while they collect rental income on the property. An investment property loan is different from a standard home equity loan in that it provides both money and collateral but lacks any “protection”.

What is an Investment Property Loan Structure?

Investment property loan structures are designed to meet investors´ needs, and there is no one size fits all solution.

Most home-buyers have trouble getting a decent rate on their mortgage, so it should come as no surprise that investors have an even harder time. Banks generally perceive them as higher-risk borrowers who do not qualify for standard funding due to lower income levels or lack of business track record.

Even self-managed super funds (SMSFs) can be treated with suspicion by some lenders. As a result, they often have difficulty obtaining finance at the best rates available without additional guarantees over the property they wish to borrow against.

Investment Property Loans – The Options

How to structure investment property loans?

Banks will typically offer a limited number of loan structures to investors:

Fixed-rate: is either for owner-occupiers or what banks call owner-occupied and investor (OOBI) loans. These are not set up as investment properties. The borrower can change them during an interest rate review, but it may mean buying out the existing fixed rates of other borrowers on that loan facility.

Variable-rate: these are current “vanilla” products that do not require additional security, such as the equity in another property or personal guarantees, but generally have higher variable interest rates than standard home loans.

The default period is usually 1-3 months compared with three months for a standard home loan, but there is no penalty interest.

First Home Buyers: these are designed to help borrowers who have been unable to get finance elsewhere through the grant/bonus system. They usually need a guarantor and often do not allow switching from the fixed-rate option.

Margin loans: this is a form of investment property loan where the bank lends you money against your existing equity in another investment property, using that as security for the new loan.

The amount you can borrow depends on how much equity you have in your other properties, and it may be restricted to borrowing up to 70% of the purchase price of the new property. You will normally pay close attention to what penalties if you sell or refinance your existing property. These can result in you losing all your equity.

Investment loan: this is the most complex on the market and means that the bank will buy the whole property from you, hold it as security for your new loan then rent it back to you.

The application process includes a valuation of the property to be sold and a review of purchase price vs. original valuation before deciding whether to accept or reject. Some lenders may ask for additional precautions such as personal guarantees from both borrower/s and guarantors or a higher interest rate than usual.

The lender will also want a breakdown of how much money you have available to fund costs at settlement, including stamp duty, legal fees, vendor mortgage rates, and any other expenses added to the loan.

For this reason, you should have an available significant proportion of the purchase price before entering into negotiations to buy a property, as fixed rates will usually be set at an amount over your entire borrowing capacity.

Be cautious about signing up for a long-term fixed rate – there may be no penalty period, so it is possible that interest rates could fall below the fixed rate you have locked yourself in to by signing a contract. On the other hand, if they rise above it, you may not be able to take advantage of those higher rates.

Interest-only: this type of investment property loan does not require any repayment of principal during the life of the loan unless you choose to do so. As the monthly repayments are lower than with principal and interest loans, they are an attractive option for investors who expect the value of their investment to go up over time.

Principal and interest: these are some of the most popular choices for borrowers who want lower repayments each month but know that at some point during the term of the loan, they will need to start making extra repayments towards their principal.

They allow you to make additional voluntary repayments but bear in mind that generally, this is done by closing your home loan (purchasing it out) and re-opening a new loan with future repayments which you can afford.

It does not usually increase your borrowing capacity without additional security, such as another property that you own or putting money into a separate account set aside for this purpose.

Redraw facility: The final main type of investment property loan is the redraw facility, where you can withdraw any money over and above your minimum repayments from the account at any time.

These loans have a “restricted” status which means that you cannot pay them off early without paying a penalty interest rate, so it is essential to choose a loan that will meet your needs for flexibility and security.

Investment property loans are available from most banks, but they generally offer more flexible repayment options than home loans because regular principal repayments are not required. This does mean that they carry higher interest rates as an incentive for borrowers to be cautious about how much they borrow.

You may also need to provide additional security, such as another property or funds in a separate account set aside for this purpose.

Before you sign on the dotted line, compare interest rates and features such as redraw/repayment facilities so you can be confident that your investment property loan will suit your needs now and in the future.

How Can We Help?

We are DFW Specialty Lending, a trusted loan facilitator to financial institutions. We are different from traditional lenders because our focus is on specialty lending such as mortgages or home equity loans. We partner with you to ensure your borrowers get the right products for their needs and fit into your credit policy.

Written by: Kendrick Sonnemann

Kendrick Sonnemann is a recent college graduate of Texas A&M University that has developed a passion for writing and bringing his ideas to life. As a freelance writer in the Dallas, TX area, he has written countless articles to help promote his personal writing brand.