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Guide To Mortgages For Investors

Contributor:
Securities Commission
Securities Commission

Many people borrow money to buy investment properties, aiming to benefit from rising property values or to earn rental income.

If this is in your plans, you'll want to shop around to compare
fees, interest rates and services just as you would if the loan was for
your own home. But there are some additional things you'll need to
consider which can have a big impact on your investment returns.

In this section you'll find information about:

  • Lending criteria for investment loans
  • Tax deductibility of the loan interest
  • How borrowing affects your investments returns and risk
  • Whether and when to repay the loan

Lending criteria for investment loans

Many lenders provide loans for residential property investments at
the same interest rates and fees as their ordinary home loans. Some
lenders will even lend to 95 percent of the property value. But a few
lenders have lower lending limits for investors, or will lend a lower
proportion of the property value if you're buying an apartment, or a
residential property outside the urban areas. This just reflects the
higher risk lenders are taking.

As with ordinary home loans, lenders will look at what you can
afford to repay. For example, a lender might prefer that the interest
on the loan should not be more than 75 percent of the gross rental
income and 35 percent of your gross personal income.

You can also expect to pay a 'low equity premium' or 'mortgage indemnity insurance' fee if you borrow over 80 or 90 percent of a property's value.

Tax deductibility

One of the key differences between a loan for your own home and for
an investment property is that the interest on a loan taken out for
investment purposes is tax deductible. It doesn't matter whether the
property used as security for the loan is your own home or one you rent
out - it's the purpose of the loan that is important.

If you rent your old home out and borrow money to buy or build
another home to live in, then the interest is not deductible, since the
purpose of the loan isn't investment. Similarly if you borrow on your
rental property to buy say a boat, the interest will not be deductible.

Some lenders and brokers have particular expertise in lending for investment.

How borrowing affects your investment return and risk

The larger the proportion of a property value you borrow, the larger
the risk you face and potential returns you can earn. If you only have
a little bit of equity, your own money in a property, then increases in
the property value will magnify the returns on that money.

But it can also accelerate losses if values fall.

Apart from falling property values, other risks you need to consider
are interest rate rises, long periods when you can't find a tenant, or
if you lose other income you rely on to help support the loan.

Some investors set out to make a loss on their property investment,
at least in the early years. This is called 'negative gearing'. It
occurs when the income you earn from a rental property is less than the
costs you face. The loss you make can be offset against tax you pay
elsewhere, for example on a salary. Investors who make a loss on a
property that is negatively geared are counting on capital gain to more
than offset the loss over time. They are still losing money in the
short-run, however.

Whether and when to repay the loan

Many investors who want to build up a number of properties take
interest-only mortgages. This helps cash flow which can be used for
upgrading properties so rents can be lifted, or to provide deposits for
more property purchases. If you still have a mortgage on your own home,
it allows cash to go towards paying this off.

If you only want one or two rental properties, you expect little
growth in property values where you live, or you are nearing
retirement, paying off investment property loans will help you reduce
risk.

 

Content provided by Sorted.org.nz, Your Independent Money Guide.

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