Are you on the fence between buying a home to live in or an investment property?
Maybe you are confused about how the two are treated differently? You are not alone!
In fact, many people don’t know the differences before they make the decision and find out all the little sneaky details later.
That’s why we’ve put together this very short summary of the most common ways investors can expect to be treated differently from home buyers.
It’s no secret that the current market environment favors investors. With big leaps in capital growth happening consistently year on year, many investors have taken advantage of their equity and have been using it as deposits for new properties.
The Australian Prudential Lending Authority (they are sort of like the policemen for the banking industry) thought that there was a little bit too much investor activity in the market and decided to put up some extra barriers for investors.
What that means now is that it is very difficult for investors to get loans if they have less than a 20% deposit. Although some banks still offer loans for investors who only have a 5% deposit, they generally have other specific criteria you or your prospective property must meet.
The loans available to investors generally have different features to those available for homebuyers.
For example, many investors don’t want their investment property to consume their personal income. They want their property to be adding to their weekly cash flow from day 1. However, this is not always possible and sometimes they need to wait a year or two and raise rents until they completely cover the principle and interest repayments on the property.
This is exactly why interest-only periods are so popular with investors. It allows them to only pay the interest due on their loan, and not pay down the principal until they are in a better financial position. This approach can make a big difference to their cash flow, and perhaps let them buy and hold more investment properties than they otherwise could.
For instance, if you had the 3.89% $500,000 investor home loan given in the example above, your principal and interest repayment of $2,355 would fall to $1,620 if you chose an interest-only repayment. This is a massive $734.65 difference in your monthly repayments.
Other handy features investors like to look for include interest off-set accounts and redraw features so that they can use their savings to offset their loan interest but then withdraw it when they need it for renovations, repairs or new investment purchases.
From a lender’s perspective, an investor is a riskier customer to lend money to. The investor is probably heavily reliant on rental income to fund the mortgage repayments and is unlikely to be able to afford the property without this rental income.
To protect themselves against the slightly higher risk posed by investors, banks will only offer higher interest rates for investment loans. The difference varies, however generally it is a 30 – 40 basis point gap between investor and home buyer loans. Over the long run, this can make a big difference.
For example, say you have a $500,000 home loan for 30 years at 3.30%:
Monthly repayment = $2,189
Total loan cost over 30 years = $788,319
But if the rate on that loan decreased to 3.00% things would look very different:
Monthly repayment = $2,108
Total loan cost over 30 years = $758,887
You’ll end up paying $29,432 less
Fortunately, if you are an investor the interest you pay on a loan is tax-deductible. That means that any interest you pay can be used to negate the tax you pay on your investment property income.
Similarly, other holding costs such as council rates, repairs, improvements, management fees, etc. are also considered business expenses and are tax-deductible. Woohoo!
On the topic of tax, there is a flip side. You will need to pay tax on any income your property makes, but we’d say that’s a good problem to have as it shows you are in profit from your investment.
You will also need to pay Capital Gains Tax when you sell an investment property, however, this does not apply to a personal home.
Unless you decide to buy a negatively geared property – and 99% of the time we’d say DON’T – then your cash flow will be looking good by holding investment property.
But you shouldn’t get too comfortable. Just like with a home, things break down unexpectedly and accidents happen. As a homeowner, you have the leisure of turning a blind eye or taking your time to fix these. However, as a landlord, you need to be on the ball and get things repaired ASAP, or risk angry tenants or even worse…legal action. It may sound scary but it’s true, there are certain things which the law requires landlords to fix within time frames as short as 24 hours.
A simple way to protect yourself is to make sure you have a cash buffer of $10,000 on hand. That means if a hot water system breaks down then there is no need to sweat because you can afford to replace it right away.
Both your own home and investment property will grow in value over time. The difference is that an investment lets you take advantage of that growth in value, whereas a home doesn’t.
Why? Well, let’s look at this example. Say you bought a house for $300,000 and now years later it is worth $700,000. While you have $400,000 net worth on paper you don’t feel wealthier. That money is locked into your house, and you can’t sell your house because you need somewhere to live. Even if you did sell it, you would not benefit as all the other properties have also risen in price.
Now let’s say that you have a house but also have an investment property. You can sell that investment property and pocket the profit. You could even use it to pay down the debt on your home.
Grants & Concessions
Generally speaking, investors are not able to access any special First Home Buyer Grants, Stamp Duty concessions and government saving schemes – unless they decide to live in the property for 12 months first.