Want to buy an investment property? From negative gearing to tax deductions, there’s a lot to learn. Find out the risks and rewards of property investment.
25 November 2022
4 minute read
Buying property is a popular investment choice for many Australians. A property is a physical asset that could help you earn extra income now and at the time of selling.
But there’s a lot to learn. In this article, we’ll explain what an investment home loan is and how it differs from an owner occupier home loan.
We’ll also go through some of the pros and cons of property investment, how to get started, positive vs negative gearing, interest only loans and other things to be aware of.
What is an investment home loan?
An investment home loan is a specific home loan type used to help fund the purchase of an investment property.
Investment home loans can offer many of the same features that a regular mortgage offers, including offset accounts, a redraw facility and fixed and variable interest rates.
What’s the difference between a regular mortgage and an investment mortgage?
You can expect to experience some differences between a regular mortgage (i.e. owner-occupied) and an investment mortgage.
If you intend to live in the home, you’ll need a regular owner-occupier home loan. If you plan to rent out or ‘flip’ the home, you’ll need an investment mortgage.
Some of the key differences between the mortgage types are:
With an investment mortgage, you can expect a higher interest rate.
It’s extremely important to be honest when applying for a home loan. If you apply for an owner occupier home loan for an investment property you could land yourself in a lot of trouble.
This is considered as occupancy fraud and is something that lenders readily look out for.
Investment properties come with a number of tax benefits and expenses that you can claim as tax deductions, including interest costs.
Owner-occupied properties don’t come with the same tax treatment.
Investors should also be aware of capital gains tax (CGT) that may be charged when selling an investment property.
It’s a tax charged on any profit you make after selling your investment property. However, if you wait at least 1 year before selling your investment property, you’ll get a 50% CGT discount.
Some banks have stricter lending standards for investors. For example, they may require a minimum deposit of 20% (maximum 80% LVR).
While lenders generally prefer that owner-occupier borrowers have a deposit of at least 20%, there is usually more flexibility.
Remember that for both loan types, a higher LVR typically attracts a higher interest rate.
You can learn more about saving and budgeting for an investment property here.
What does an investor need to do to get a loan?
The application process for an investment loan is largely the same as for regular home loans. Here are the basic steps:
What are the potential rewards of property investment?
Property investment can come with many benefits which is why it remains such an attractive investment option. Here are some of the potential rewards of property investment:
Unlike investing in shares, for example, which can be unpredictable and volatile, investing in property tends to be more stable.
While property values often fluctuate, they tend to do so slowly, so you can plan your next move.
Most investment property expenses are tax deductible which can save investors a lot of money. Some tax deductions that property investors can claim include:
If you find tenants, you’ll earn rental income. This income can help you cover mortgage repayments and the costs of owning an investment property.
Remember that having your property tenanted doesn’t necessarily guarantee you a profit.
Investing in property tends to be less complex and require less specialised knowledge than other investment types.
There is a lot of information available online about it, as well as many experts you can reach out to if you need help.
For example, most mortgage brokers don’t charge fees for their services and can be immensely helpful in helping borrowers find and apply for home loans.
On the flip side, however, property investment has a much higher entry price. You don’t need a lot of money to start investing in the stock market, whereas you typically need tens of thousands of dollars – at minimum – to start investing in property. You have to cover the deposit and stamp duty somehow!
Properties have the potential to appreciate in value significantly over time. This means that you could purchase a property for a low price and sell it at a profit after a few years.
If growing the value of your investment is a priority for you, look to buy in areas that are likely to experience future growth. Look for schools that are improving on rankings, as well as council plans for intended development and infrastructure (e.g. new public transport lines).
If you want to get your foot on the property ladder but can’t yet afford to buy in the suburb you would like to live in, you could consider rentvesting.
Rentvesting is where you continue to rent in your preferred location while purchasing an investment property in another area.
This way, you start to earn rental income and get used to the ins and outs of owning a property while remaining in the suburb you love.
What are the risks of property investment?
While property investment is generally considered to be a ‘safer’ investment type, it’s not without potential risks. These may include:
Many investors purchase a rental property with the assumption that it will grow in value and that they’ll be able to sell it for a healthy profit after a few years.
Unfortunately, this is not always the case. Based on factors outside of your control – such as the ever-changing property market, infrastructure and development near the property and supply and demand – your property could decrease in value.
Declining property values can have multiple negative impacts, including:
Properties can’t be converted into cash in an instant like you might be able to do with some other investments. Selling can take a lot of time and if you sell quickly out of necessity (e.g. needing access to a lot of cash), you might not get the best sale price.
If liquidity is something you value in an asset, you might prefer to focus on other investments or create a diverse portfolio.
Another risk of property investment is having bad tenants. Maybe they have damaged the property, are late with rent or refuse to pay, or perhaps they are disruptive to neighbours.
Having difficult tenants like this could result in high costs and stress, but there are ways to prevent these issues:
Simply owning an investment property won’t guarantee a line of potential tenants at your door. Some investors even go through long periods where their property is vacant.
If you are going to be relying on rental income, select the type and location of your investment property carefully.
Properties in lively areas with plenty of amenities, public transport and schools are likely to have higher rental demand.
Not being able to find tenants could mean that your property becomes negatively geared. While this won’t suit the goals of all investors, it does mean you can write your losses off on your tax return.
Owning a rental property does not guarantee you rental income. Owning a property comes with many expenses, including a mortgage in most cases.
Mortgage repayments and associated costs can fluctuate and sometimes be greater than the rental income you receive.
All properties are at risk of physical damage, but the risk can be higher for an investment property since you are not the one living in it.
Investors should be prepared to deal with any potential damage that may occur.
Often major damage can be prevented, so listen to your tenants when they tell you there’s a problem.
Delaying repairs and maintenance could cost you far more than undertaking minor repairs.
If you have a variable interest rate, you can expect your mortgage interest rate to fluctuate somewhat. If interest rates rise, this could negatively affect your cash flow.
Investors who like stability regarding their home loan repayments might prefer to opt for a fixed interest rate.
What should you consider when choosing to invest?
While property investing is a more straightforward way to invest your money, there’s still a lot to think about before getting started.
Here are some things to consider when planning to invest in property:
Can investors get interest only home loans?
Yes, interest only home loans tend to be most popular with property investors.
An interest only home loan is where the borrower is only required to repay the interest that accumulates on top of the loan amount (principal).
During the interest only period – which can typically last for 1-5 years – the borrower is not required to make any repayments on the principal. This means that you aren’t paying off your home loan balance – only the interest on top of the principal.
Once the interest only period expires, the borrower will then have to make principal and interest repayments.
Many investors will purchase an investment property with the goal of selling it at a gain after just a few years. An interest only loan can help maximise their profits.
This is because interest repayments are tax deductible for property investors, so they can keep their property expenses very low. These investors can spend their extra money on other investments, while waiting for the optimal time to sell the investment property and make a profit.
It’s important to note that this strategy won’t always be effective due to the unpredictable nature of the property market. That is; your property won’t necessarily increase in value as you expect it to.
Positive and negative gearing the right property
Understanding positive and negative gearing is essential as a property investor.
When a property is positively geared, your investment income surpasses your investment expenses. In this case, you have a positive cash flow.
When a property is negatively geared, the opposite occurs. Your investment income is lower than your investment expenses, creating a negative cash flow.
For many borrowers, a positively geared property is the goal. You’ll get extra money in your pocket to put towards other investments or spend however you like.
However, negative gearing can actually be an investment strategy. The short-term losses you get with a negatively geared property can usually be written off as tax deductions.
Additionally, if the investment property grows in value, these losses will be offset by significant future capital gains when the property is sold.
For negative gearing to work, you’ll likely have to buy property in an area that is expected to experience high growth.
There’s a lot of information to absorb when considering property investment. If you're feeling lost or need more information just give us a call and we can lead you in the right direction