Investment property financing & planning basics for investors
Real estate can be a great way to grow your money. Properties can increase in value over time (capital appreciation), and you’ll earn rental income every month.
But like any investment, it comes with its own set of challenges. The market can have its ups and downs (volatility), finding tenants isn’t always guaranteed (vacancies), and keeping the property in good shape requires ongoing maintenance costs.
The important thing is to weigh the potential benefits against the risks before you dive in. By understanding both sides of the coin, you’ll be in a strong position to decide if real estate investing is right for you.
So let’s start with the basics.
Choosing the right type of loan for your property
There’s a key decision you’ll need to make upfront: what type of loan is right for you? There are two main options: investment loans and owner-occupied loans.
Investment loans
Investment loans are designed specifically for properties you plan to rent out or resell for profit. For lenders, these loans come with a bit more risk. Since your repayment relies on rental income, factors like finding tenants and market fluctuations can make things unpredictable. To offset this risk, investment loans typically have higher interest rates and fees compared to owner-occupied loans.
Imagine you’re buying a $500,000 investment property. The interest rate on an investment loan might be 0.5% to 1% higher than an owner-occupied loan. That could mean a difference of $1,392 per year on a $400,000 loan (after a 20% down payment). But what is an Owner-Occupied Loan?
Owner-occupied loans
Owner-occupied loans are for properties you’ll be living in yourself as your primary residence. Because you’ve got a vested interest in keeping up with payments, lenders see this as a lower risk. As a result, owner-occupied loans typically come with lower interest rates and fees, making them a more affordable option.
So, which one is right for you?
The best loan type depends on your situation. So ask yourself some important questions
- Can you comfortably cover the mortgage if the property sits vacant for a while? This is especially important for investment loans.
- How much rent can you realistically expect to charge? Can it cover the mortgage payment on an investment loan?
- Are you looking for steady rental income or hoping to sell the property for a profit in the future?
By choosing the right loan and asking the right questions, you can maximize your returns while keeping risks under control.
But how do we get approval for the loan in the first place?
Loan approval process: pre-approval vs. Unconditional approval
Pre-approval is like a preliminary green light from the lender. They assess your financial health (credit score, income, debts) and give you an estimate of how much you can borrow. This effectively sets your budget boundaries for your investment property search. Now you can focus on properties within that price range and make your search more efficient and targeted. Pre-approval typically lasts 90 days, giving you ample time to find your ideal property.
Unconditional Approval is the final stage and the one you’ve been working towards. Once you’ve identified your ideal property, the lender will thoroughly review both your finances and the property details. If everything meets their criteria, you’ll receive the coveted “unconditional approval.”
Why is pre-approval important for you?
Pre-approval offers a strategic advantage, especially in competitive situations like auctions. With pre-approval in place, you can confidently bid up to your approved amount as you know your loan is likely to be finalized later. This gives you a significant edge over other buyers who haven’t secured pre-approval and might be scrambling for financing at the last minute.
Even if you secure a loan, there will be a constraint of down payment. This is one of the biggest hurdles to becoming a property owner. So what can be done?
Down payment strategies
The 20% down payment
The traditional advice is to aim for a 20% down payment as it allows you to avoid Lender’s Mortgage Insurance (LMI). LMI is like an insurance policy for the lender, not you. It protects them if they can’t repay their loan and the property sale doesn’t cover the remaining balance.
Let’s say you’re looking at a $500,000 property. A 20% down payment would be $100,000. If you can only swing a 10% down payment ($50,000), you might have to pay LMI. The cost can vary, but it could be around 2% of the loan amount. On a $450,000 loan (with a 90% loan-to-value ratio, or LVR), that could be $9,000 added to your loan or paid upfront.
Down payment options for those saving up:
Guarantor Loans: This option allows a family member to use their property as security for your loan. If you default, the lender could go after them to recover the money. This can help you borrow more than 80% of the purchase price without LMI.
- Imagine your parents agree to guarantee $50,000 of your loan for a $500,000 property. With their help, you’d only need to borrow $400,000 plus your $50,000 down payment. This keeps your LVR at 80%, allowing you to avoid LMI.
Exploring Affordable Markets: If saving a 20% down payment in a pricier area feels out of reach, consider a more affordable market. In these areas, your savings might cover a 20% down payment more easily and potentially eliminate the need for LMI.
Now since the loan type is decided, let’s also consider the interest type.
Fixed interest loans
Fixed interest loans lock in your interest rate for a set period, typically 1 to 5 years. This offers stability and predictability for your monthly payments. You can plan your finances for the long term with the comfort of knowing exactly what your monthly payment will be.
However, there’s a catch: fixed rates lack flexibility. If interest rates drop overall, you won’t benefit from that decrease. Additionally, there can be hefty fees if you decide to pay off the loan early or switch to a different loan product.
Variable interest loans
Variable interest loans, as the name suggests, adjust based on market conditions. This means your monthly payment can fluctuate up or down. While this might sound risky, it also presents an opportunity. When interest rates go down, you’ll enjoy lower rates and potentially smaller monthly payments. Variable loans often allow you to make extra payments without penalty, which can significantly accelerate your loan payoff.
So, how do you decide which loan is right for you?
- Locking in a low fixed rate is smart if rates are expected to rise.
- Fixed rates are ideal for those who prefer stability.
- Fixed rates can be beneficial when inflation is rising.
- Variable rates can save you money if interest rates are expected to fall.
- Shorter loans might make variable rates less risky.
- Diversify your interest rate exposure with a split-rate mortgage (combines fixed and variable).
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Thinking outside the bank
Traditional lenders often have rigid requirements. Alternative financing offers a breath of fresh air for those who don’t quite fit the mold, or who simply want more flexibility. Here are a few options to consider:
- Private Lending: Instead of focusing solely on your credit score, private lenders base their decisions on the property’s potential. This can be a faster and more adaptable option, but be prepared for potentially higher interest rates.
- The Power of Crowdfunding: This isa platform where multiple investors join hands to fund a property purchase. It allows smaller investors to participate in bigger projects, lowering the barrier to entry and making those dream deals more accessible.
- Partnership Investments: Sometimes, collaboration is key. Joining forces with other investors can significantly boost your buying power while spreading out the risk. Partners contribute capital and share the profits proportionally, making larger investments a realistic possibility.
- Self-Managed Super Funds (SMSFs): Ever considered using your retirement savings for real estate investment? SMSFs allow you to do just that! However, SMSFs come with specific regulations and require careful management to ensure compliance with superannuation laws.
By exploring these alternative financing methods, you can unlock a world of possibilities beyond traditional lenders. So, don’t be afraid to think outside the box – your real estate dreams might just be closer than you think!
Financial planning and budget management
Unexpected repairs, maintenance needs, or even vacancy periods can disrupt your cash flow. Having a financial buffer ensures you can handle these situations without financial strain.
Budgeting Like a Pro
- Saving for Your Down Payment: First things first – know your goal! Figure out how much you need to save for a down payment and dedicate a specific savings account for it. Consider setting up automatic transfers from your checking account right after payday. This way, saving becomes effortless!
- Expect the Unexpected: Life happens. Allocate a portion of your budget specifically for unexpected property-related expenses. This could be a separate savings account or a readily accessible emergency fund.
- Rental Rate Reality Check: Don’t just guess what your rent should be. Research your market to set competitive yet profitable rental prices. Regularly review and adjust these prices based on what similar properties are renting for. This ensures you cover your costs and generate a good return on your investment.
The takeaway
Financial planning and budget management are equally important for long-term success in property. But when in doubt, don’t hesitate to consult with financial experts! At the Investor’s Agency, we can provide personalized advice based on your unique financial situation. This professional guidance can help you make informed decisions, maximize your returns, and minimize the risks associated with property investment. So, don’t be afraid to seek help – a financial expert can be your partner in building a thriving rental property portfolio.
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Gemma Kim2024-04-04We worked with TIA to purchase our first investment property. We were a bit nervous to take the leap initially. However, the team were so helpful and supportive throughout the whole process. The process was clear and informative at every step. The team were readily available to answer questions. Thanks to the team and their expertise we have walked away with an incredible investment property which is already showing signs of return and growth after a very short period of time. We have full confidence in TIA and we look forward to working with them again for the next investment opportunity.Yechan Kim2024-04-04Amazing service and attention to detail from the entire team. We managed to secure a fantastic investment property as a great price. The research, information, communication is levels above other buyer's agents. Will be coming back for 2nd and 3rd properties.Noah Chen2024-04-04Absolutely elated to choose The Investors Agency as my buyers agent. I have bought 2 properties with The Investors Agency, first one with Bobby in 2020 and second time with Mitch & Mike in 2024. I came back because of the strong results with my first property and also the service the team provided. TIA always made me feel comfortable with decisions and always informed and work hard to get the best deal which suit our investment needs. Their process and technology is top-notch and makes the investment property purchasing journey very stress free all the way to post-settlement. I found the value of TIA as my buyers agent through off market deals, time-savings, a deep understanding of growing markets and the detail of property inspections/information for an interstate property. I will definitely recommend building your investment property portfolio with TIA as it’s been a great journey for me.Eric Marchant2024-03-26The Agency gives solid financial advice and backs it up with the support needed to implement itNoa Lamm2024-03-16We're thrilled to share our positive experience with The Investors Agency. When we were searching for an investment property in Perth, they proved to be the perfect partner for us. From the outset, The Investors Agency demonstrated professionalism, attentiveness, and a deep understanding of the real estate market. They listened carefully to our investment goals and worked tirelessly to find us a property that aligned perfectly with our objectives. Throughout the process, The Investors Agency was incredibly responsive and organized, making the entire purchasing experience smooth and efficient. Their attention to detail and commitment to excellence were evident every step of the way, making us feel confident and supported throughout the journey. Thanks to The Investors Agency's expertise and dedication, we were able to secure a beautiful property that has already shown promising signs of appreciation in value. Their insight into market trends and investment opportunities was invaluable, and we couldn't be happier with the outcome. We highly recommend The Investors Agency to anyone looking to invest in real estate. Their professionalism, integrity, and exceptional service make them a standout choice in the industry. Thank you, The Investors Agency, for helping us achieve our investment goals in Perth.Tiyanah Doyle2024-03-16I had such a great experience working with the investors agency, Mitch made my first investment property purchase so easy. Mitch had really great communication and was always available via text/call/email. As it was my first property purchase I felt supported and guided by their expertise and everything is presented in a user friendly way. I would definitely recommend the investors agency and would use them again. They also mortgage broker who is excellent.Natasa Igrac2024-03-11We had a great experience working with the TIA team in helping us secure our 1st investment property. It was a very smooth process! The team was always there to answer all questions that we had along the way. We are definitely looking forward for our next investment property with them and we can't recommend them highly enough to anyone looking for a knowledgeable and supportive buyers agency.Greg Kite2024-02-29We have just settled our first property with the guidance of The Investors Agency. The process was smooth and transparent from our initial enquiry to final handover. The Investors Agency made recommendations when required and everyone involved was professional and valuable. A big thanks to James and the whole TIA team..... Where are buying the next one guys?Eva den Haan2024-02-28The Investors Agency has been super helpful with the purchase of my first investment property. They did all the hard work and communicated with all relevant parties on my behalf, while still making sure I was constantly up to date with the latest developments. The whole process felt very personal and I would highly recommend the team to anyone looking to buy an investment property.Vicki Milekovic2024-02-26We’ve had such a great experience! From start to finish the investors agency has been so helpful and responsive. They have gotten us exactly where we want to be and made the process so easy. We look forward to our ongoing investing journey with them!
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