Using equity to buy your investment property Many Australians are now tapping into their “pot of gold” - the equity in their home - allowing them to invest for the future and forge ahead financially.
Tapping into your home equity (or equity from another investment property), is a great launching platform for buying an investment property. Say your home is valued at $500,000, you owe $150,000 on your mortgage (thereby giving you equity of $350,000) you may want to invest a portion of the equity into another property.
Ideally, investment property loans should be interest only because an interest only investment loan is FULLY tax-deductible. It is usually the best cash flow solution when used with good capital growth. However there are other categories of loans that may be considered.
Interest only loans
With an interest only loan your repayments are set to cover the interest component of your loan only, which allows you to keep your repayments on your investment property to a minimum.
Generally, interest only loans are for a maximum five year term (depending on your lender) reverting to a principal and interest loan at the end of the agreed interest only term. However a further interest only loan can be negotiated at this time. The interest on your investment loan is tax deductible, making these types of loans attractive to investors.
Fixed rate loans
These loans are set at a fixed rate for a specified period - usually one to five years. Repayments do not rise or fall with interest fluctuation throughout the specified period. At the end of the term you can lock in another fixed rate, switch to variable or go for a split loan. These loans may have limited features and lack the flexibility of variable loans. There may be early exit fees and limited ability to make extra payments.
Basic or “no frills” loans
These are variable rate loans with a relatively low interest rate. Repayments will rise and fall with interest fluctuations. With these loans, remember to check that the loan conditions will suit your circumstances, particularly the ability to make additional repayments and pay out the term of the loan without a penalty.
Standard variable rate loans
The standard variable rate loan, like a basic or “no frills” loan, offers more flexibility than a fixed rate loan. A standard variable rate loan will often have more features than the basic variable option so the rate may be slightly higher. The extra options (for example a redraw facility, the option to split between fixed and variable, extra repayments and portability) should be taken into account when choosing your type of variable loan. Repayments will vary as interest rates fluctuate.
Mortgage protection and lender’s mortgage
Mortgage protection and lender’s mortgage insurance (LMI) are for two different situations. Mortgage protection is insurance that supports you in case you become involuntarily unemployed or are unable to work due to illness or disability. It makes sense to ensure that you can continue to meet your commitment in the case of unforeseen events. However lender’s mortgage insurance is usually required where your deposit is less than 20% of the purchase price of your property and protects the lender in the event that you default on your repayments.
Life insurance provides a lump sum payment to your beneficiaries in the event of your death. If you are the main income earner in the family, this insurance will help your family manage their future (for example paying out mortgages, schooling and other family expenses) without your ongoing earning capacity.
Landlord insurance is a policy to cover an investment property owner from financial losses. Common features of a landlord insurance policy include malicious or intentional damage to the property by the tenant or their guests, theft by the tenant or their guests, loss of rent if the tenant defaults on their payments, liability including a claim against you by the tenant, and legal expenses incurred in taking action against a tenant.
TPD - total and permanent disability
You can choose to cover yourself for either total or permanent disability or death options, providing you can no longer work or in the event that you die due to illness or accident. When combined with life insurance, this can provide security for you and your family for the rest of your life.
Building insurance should provide you with adequate cover in the event you need to repair or replace your investment property (ie home, garage, shed). Income protection Income protection insurance pays you a predetermined percentage of your monthly income should you be unable to work due to illness or injury.