How does an investment home loan work? 

Investment home loans function much the same way as owner occupier home loans, in that banks will lend a certain amount to a borrower, an interest rate (which will be either variable or fixed) will be applied, and borrowers will be expected to pay off the principal and interest in regular installments over the life of the loan. 

There are, however, a few key differences between the two. Along with the difference in LVR requirements, investment loans generally come with a higher interest rate than those offered to owner occupiers (though with interest rates currently at all-time lows, the difference might not be too much to worry about). You can also expect some additional closing costs, like an appraisal fee.

What do banks look at when issuing investment loans?

As with any other loan, banks will want to see that you have a good credit history, genuine savings and stable employment, but you might have to jump through a few more hoops. For example, a lender might request a statement of potential rent from a real estate agent. 

Typically, lenders would consider around 80% of rent from investment properties in their income assessments. But in the current climate, it’s not unusual to have a discount of as much as 50% applied to rental income. That means if you intend to rent out a property for $500 per week, your lender will only count $250 of that when determining your ability to service a loan.

Choosing the right investment home loan

Once you know you fulfill the requirements when it comes to the amount you’re looking to borrow, it’s time to think about the type of investment property loan you’ll sign up with. One of the more popular options is choosing an interest only home loan. Read on for a full definition:

Interest only home loans

As the name suggests, unlike a standard home loan where you repay both the principal and the interest, with an interest only investment loan you’ll only repay the interest. This means that your ongoing repayments will be significantly lower.

Consider this scenario: Sarah wants to borrow a total of $500,000 paid back over 25 years. Our home loan repayments calculator shows that with a 3% interest rate, if she chose the principal and interest repayment option, her monthly repayments would be $2,371. But if she opted for the interest only option for the first 5 years, during this period her ongoing payments would be brought down to $1,250.

Another reason interest only home loans are a popular option for investors is because of something called negative gearing, which means if the cost of repayments and looking after the property is more than your returns in rent, you can claim the home loan interest and property maintenance come tax time and potentially get a partial to substantial refund on that amount.

While the interest only period won’t last forever (generally just 5 years) and you’ll eventually have to start paying off both the interest and principal, you could negotiate at the end of the interest only period to have it extended for another 3-5 years.

But keep in mind, interest only home loans aren’t for everyone. The whole point of an interest only loan is you’re relying on your property’s value to increase over time. This can be risky if you’re buying in an area that could see a drop in property prices down the track, so in this instance you may be better off paying down both the principal and interest.

Variable, fixed or split interest rate?

Whether you choose an interest only investment loan or the standard principal and interest repayments, you’ll be able to choose the type of interest rate to suit you.

• Variable interest rate: The more popular option in Australia is the variable rate option, which changes in line with the official cash rate. The reason many investors opt for variable rate home loans is because they generally come with more features than fixed rate loans like an 100% offset account, which allows you to bring down the amount of interest you pay.
• Fixed interest rate: By comparison, a fixed interest rate will mean your rate is locked in for the fixed rate period. While more and more providers are introducing fixed rate loans with an extra repayments facility (with a cap of around $10,000 per annum), fixed rate loans generally don’t come with an offset account.
• Split interest rate: You could also consider splitting your investment loan, which means a portion will be variable allowing you to enjoy the benefits of an offset account on the variable amount and the remainder will be fixed giving you some security if your lender lifts rates.

Comparing investment loans interest rates

Picking up your first investment property can be an exciting time, and having the right loan and interest rate on your side can help you save a bundle. Our Home Loans Interest Rates page not only makes home loan comparison easy, but allows you to find the right interest rate for your needs.