Financing the investment property

There is some debate regarding the type of loan that should be used to finance an investment property. There is no hard and fast rule, but most property investors observe the following strategy:

If they have debt on their owner occupied property, they concentrate on paying this off first. This means that they have an Interest only loan on their rental property and make all principle payments onto their home loan. This is because the home loan is paid from after tax earnings and is effectively more expensive than the tax deductible interest costs of an investment loan.

When the home loan is paid off, investors often then choose to make principle payments on their investment loans. Other investors who don’t have owner occupied debt often choose from the outset to have principle and interest loans so that the debt on the rental property is paid off over time.

Some investors (regardless of whether they have owner occupied debt) choose to always have interest only loans. This is because they have chosen to invest over time for capital growth and intend to sell the property for profit at a future date.

This approach also allows the owner to have funds to invest into up-grading and maintaining the property. Such investment is often tax deductible (compared to interest payments which are not) and also helps retain tenants and market level rents.

To work out what is the most appropriate approach for your personal circumstances contact us today.

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Financing case study

Bob and Julie had a home in Wellington that had a market value of $520,000. Their mortgage was $220,000. They wished to buy a rental property valued at $400,000 and didn’t think that they had a deposit to buy it.

Combining the properties value for one mortgage

While it is true that they had no cash, they had a deposit already in their home equity. We applied to the bank to borrow the full purchase price of $400,000. This meant that their two properties had a combined value of $920,000. When their existing mortgage of $220k was added to the new one of $400k, the total borrowing was $620,000.

$620k borrowed against $920k of property gives a loan to value ratio (LVR) of 67%. Banks are very comfortable to lend to this level assuming that personal income and rental income combined are sufficient to service the borrowing.

You may well have enough equity in your home to acquire one or more investment properties.

Separate mortgages

If Bob and Julie wanted to have an investment property separated from their own home by using a second lender this can be achieved very easily. It is simply a matter of increasing the loan with the first lender to cover a 30% deposit and then borrowing the other 70% from a different lender.

We would go to Bob and Julie’s bank and borrow $120,000 for the deposit. Then we would go to another bank and apply for the $280,000 to make up the purchase price of $400,000. Both loans would be tax deductible (even though the small one is secured against their owned occupied dwelling) as they were both taken out to buy the rental property.

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