Taking Advantage of the Difference in Interest Rates on Property Loans
Are you planning to invest in a property to make it an income-generating asset? Or maybe you found a good spot where you can live and retire? Whichever the answer is, you have to consider the repayment plan and interest rates associated with the investment. Knowing the available options and which of them can work to your advantage can save you a lot of money in the long run.
Investor vs. owner-occupier home loan
The sudden surge in investor loans over the past years has alarmed the Australian Prudential Regulation Authority (APRA) to control interest rates and property prices. By limiting the allowed investor credit to 10% of the total loans provided by a lender, APRA aims to reduce the competition between people seeking for owner-occupier loans and those looking for investment loans.
The new policy forced lenders to recalibrate their criteria for approving loans and the associated discounts they provide with it. This includes reconsidering the approved loan-to-value ratio (LVR) which is one of the factors that determine the interest rates imposed on your loan. From an LVR of 95%, lenders are now accepting loans with a maximum LVR of 80%. This means borrowers should be able to pay outright the 20% value of their loan to get it approved.
Investor loan rates are now higher than owner-occupier loans by around 50 basis points. According to Finder, the average investor loan rate is at 3.89% while the owner-occupier rate is at 3.54%. Using this rate on a $500,000 loan with a 30-year repayment term, you’ll end up paying at least $35,000 more on an investor loan rate.
It seems like the investor home loan is at a disadvantage with the higher interest rates. However, that’s not the case when you consider its eligibility for tax deductions.
Interest-only vs. principal-interest payments
Interest-only, as the name suggests, focuses on reducing the interest charges on the loan, resulting in a reduced monthly repayment size. The drawback is that you’re not lessening the main amount you owe in the process. In addition to that, interest-only payments have a higher interest rate when compared to principal-interest payments.
Why go through the hassle of looking for this kind of offer when it has an even higher rate than the usual principal-interest payment? The answer lies in how the Australian Tax Office (ATO) treats loan interests.
Although property investors face higher interest rates with this kind of repayment scheme, they can enjoy the benefits provided by interest-only payments. If you’re a property investor, it’s only natural to incur expenses in an attempt to generate revenue. The ATO classifies interests incurred under business expense, meaning you can deduct it from the income your property generates. This kind of expense doesn’t apply to interests paid on owner-occupier loans since they’re not using the asset for business purposes.
This advantage is what empowers property investors to seek interest-only payments on their home loans. Not only does this reduces their monthly repayments but also maximizes the tax deductibles on their revenue. The challenging part is that not many lenders provide this kind of offer.
On the other hand, as an owner-occupier, you’re left with a principal-interest payment scheme. This means each repayment you make goes to reducing both the interest and the principal of your loan. The flexibility to choose your own repayment plan is the main advantage of this repayment scheme.
You can choose among the 3 different types of interest rates you can avail from your lender.
1) Variable rate
The interest rate on your loan changes in response to macroeconomic changes in the cash rates and policy changes implemented by your credit provider. If the rate is down, you’ll be able to repay a bigger chunk of your loan since the interest has been reduced. The opposite happens, though, when rates are high.
Usually, your lender won’t restrict you from doing additional repayments when you have a variable rate loan. You can use this to your advantage to greatly reduce your overall debt.
2) Fixed rate
Fixed interest rates are not affected by changes in the standard loan rates. This saves you from market volatility by providing you with a fixed amount to repay every period. However, this benefit may also put you at a disadvantage when interest rates start to fall.
The application of a fixed interest rate on your home loan may last only up to 5 years. This means that once this time has elapsed, you have to reassess your loan and decide whether to switch to a variable rate or renew a fixed interest plan.
3) Partially-fixed rate
Also known as a split loan, this allows you to enjoy the benefits provided by both a variable and a fixed interest rate. For example, you decide to split the repayment of your $500,000 loan by having $200,000 on a fixed rate repayment and the rest on a variable rate.
Identifying your purpose for buying a property can greatly affect your repayment options. Before getting a loan, gather all available options and compare which offer best suits your financial capacity. Banks and other lending institutions have detailed information on their loans which can be found on their websites. If you can’t find any, call them directly and maybe you can even work out on a discount on your home loans.