What Are The Benefits Of Interest
Whether youre looking to lower your monthly payments or preserve cash flow, a rental interest-only loan can help you maximize your rental strategy.
Here are a few additional rental-only benefits to consider for your next property:
- Preserve cash flow during times of rental destabilization or vacancy
- Qualify for higher leverage for your purchases and refinances
Refinance Your Mortgage To Another Interest
Failing to get an interest-only loan extension approved from your current lender doesnt necessarily mean that you cant get approval from another bank. It all comes down to policy at a particular bank.
If your current lender refused to extend the term of your interest-only loan, another option is to refinance to an interest-only loan with a different lender. You can continue to make interest-only repayments for another five years and keep your costs on your investment property down.
At Prosperity Finance, we enjoy a good relationship with many New Zealand lenders, which allows us to search through many home loan options and find the right lenders to suit your situation and needs.
The Difference Between Interest
One of the main costs you need to consider when youre taking out a mortgage for a buy-to-let property is the interest rate youll be charged and how much you could end up repaying overall as a result.
There are two ways interest can be charged on a mortgage and its important to understand the differences between them to help you make the right choice.
With an interest-only mortgage, you only pay the interest on your mortgage each month – you dont need to pay off the original loan amount until the end of the mortgage term.
Most landlords, especially those with more than one property in their portfolio, use interest-only mortgages to finance their investments.
They typically plan to sell the property in the future and make a profit from any house price inflation, as well as repaying the capital thats owed to the lender.
Some landlords use rising house prices to release equity from their properties by remortgaging, then they invest this money in new properties, this process is sometimes referred to as ‘leveraging’.
Done carefully, landlords can still remortgage to a new interest-only buy-to-let product because they leave enough equity in their property to meet the minimum loan-to-value criteria.
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Property Investors Offered 20
One of the countrys biggest non-bank lenders is going against the grain, and offering property investors the chance to lock in long-term, interest only loans.
Rising interest rates and economic uncertainty have prompted banks to ask many investor customers to move from interest-only payments to more expensive principal-and-interest payments on their mortgages.
But property lender Resimac had taken a different approach, and announced an interest-only mortgage with a 20-year term, only available to professional investors.
The interest-only option was available for up to 50% of a propertys value, while principal and interest repayments would be required for the portion of the loan above that.
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Investors who took up the loan would need a 40% deposit for an existing building, or a 30% for a new build. The loan had an 1.5% establishment fee, which could be added to the loan amount.
Resimac general manager Luke Jackson said the loan was a first for investors in New Zealand, and would help them maximise the return on their investments.
Savvy investors had a long-term lens when assessing property opportunities, but there was a significant gap in the market for loan products that accommodated this future focus, he said.
Our new loan has been purpose-built to help investors seize opportunities now and build an investment portfolio in a cashflow-effective manner.
Good Reasons For Choosing Interest Only
If youre an investor, the most legitimate reason for choosing interest only repayments is that you want to use your funds to pay off your home loan which isnt tax deductible and so you pay the minimum on your investment loans.
This is because an investor will lose some of their benefits if they pay off their loan early.
The other main advantage is that you can to make further investments, add capital value to your existing real estate through renovation work, or take care of other financial priorities like paying off higher interest debts.
Most lenders dont even ask for a reason as this is accepted as standard.
If youre then its more complicated.
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What Is An Interest Only Loan On An Investment Property
Where an interest only loan used to purchase an investment property, the loan repayments only cover the interest, not the principal. In other words, the loan amount to purchase the property remains unpaid.
The interest only period usually has a set timeframe, for example the first five years of a 30-year loan.
Several banks and lending providers offer them.
Calculate Your Repayments After The Interest
Work out how much your repayments will be at the end of the interest-only period. Make sure you can afford the higher repayments.
Give yourself some breathing room. If interest rates rise, your loan repayments could go up even more.
Work out your repayments before and after the interest-only period.
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Your Repayments Are Lower
Because youre not paying off any of the debt on the property, your loan repayment amounts are lower as youre only paying off the interest portion of the loan. This is arguably the biggest pro of an interest-only loan and one of the main reasons why investors opt for this kind of loan as it gives them repayment certainty for the first few years when trying to find tenants and minimise other starting costs.
Interest-only repayments also allow investors to maximise their cash flow by freeing up the principal amount of each repayment for other uses, such as to save a deposit for their next property purchase or pay off debts.
“Recently we’ve seen a number of our customers opting for principal and interest due to lower rates being available. That being said, increasingly our investment customers have been opting for interest-only to manage their cash flow, and renovating particularly during these lockdown periods, Marie Mortimer, Managing Director loans.com.au said.
Image supplied.
We’re noticing in general people are using their funds and additional cash flow to renovate and complete cosmetic upgrades to their kitchen or bathrooms, to add value to their property.
Its important to remember that all good things must come to an end and after your IO period expires your repayments will increase as you begin paying off the principal portion .
Case Study: When Interest Only Works
Dale and his partner had been paying off their home loan for 3 years before they decided to take the plunge and buy their first investment property.
They had cleverly been making on their mortgage during this time and, thanks to growth in the value of their property, their was at 80% of the property value.
The couple refinanced their home loan and accessed some and combined this with some of their own savings to use as a 10% deposit on a unit in a neighbouring suburb.
Dale chose a 3-year interest only term and made some extra repayments on his fixed rate investment loan whenever he earned overtime in order to reduce some of the principle.
The fixed rate limited Dale to making a maximum of $10,000 per year in extra repayments but this worked well for the couples financial situation.
In the final year of his interest only period, Dale also began depositing an extra $50 a week into his offset account just in case he needed to access those funds.
What also worked in the couples interest was that they purchased their unit in a growth suburb. So, although they purchased the unit at 90% LVR, their LVR was now at 78% LVR.
At this point, the couple were also in a position to refinance their owner-occupied mortgage, which was now at 70% LVR and, again, used equity to use as a 10% deposit to purchase another investment property.
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How Much Can I Borrow
The amount youre able to borrow will be based on the lender youve approached. This is because each lender has its own affordability assessment.
Some lenders will use your personal income to calculate how much youre able to borrow. Others will use the potential rental income from the property you wish to buy.
Why Dont The Banks Like Interest
The answer is largely to do with responsible lending. Having a large mortgage as you approach retirement is not a good position to be in. Therefore the Reserve Bank wants to see you paying down your mortgage. To appease the Reserve Bank, most banks limit the amount of time you can have an interest-only mortgage.
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What Is A Good Investment Property Interest Rate
A good investment property rate varies from day to day, as rates change based on numerous economic and noneconomic factors. To find the best rate for an investment or rental property, youll want to compare investment property mortgage rate quotes from multiple lenders.
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How We Chose The Best Investment Property Loans
We reviewed 19 lenders and their loan programs before selecting our award winners. We considered the types of investment property loans they underwrite, down payment requirements, the interest rates and APRs, minimum and maximum funding limits, and the lenders underwriting process complexity.
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What Are The Risks With These Mortgages
Theres nothing wrong with an interest-only mortgage. However, you need to be aware of the potential risks and understand what youre getting yourself into.
- Higher interest rates.Interest-only mortgages usually come with higher interest rates than principal and interest loans. But, of course, the repayments are still lower because youre not paying back the loan amount yet.
- You dont build equity.If your property doesnt grow in value, you wont build equity in your homeif youre not repaying any of the principal, which means from the day you move into the property, you dont own any more of it than the amount you paid for a deposit. You could even end up innegative equityif the property loses value.
- You pay more interest.You have to repay the loan principal eventually, and by not repaying the principal from day one, the lender charges more interest.
For the well-informed, well-organised borrower, an interest-only mortgage can work well. However, if you dont know what youre doing, it can get messy.
Worst case scenario: Interest only loan and falling property prices
Property prices in New Zealand tend to rise over time, but they can fall. If you have an interest-only mortgage and prices start to fall, you could end up with negative equity.
Imagine you bought an investment property in 2017. For three years, you make interest-only repayments. You have trouble renting it out, but you are waiting for the property to grow in value.
Can You Make Principal Payments On An Interest
This may surprise you but at most banks you can make additional principal payments, without break cost penalties. Most banks either allow you to increase payments or make a one-off lump sum payment on your loan, even if its an interest-only loan. So if you find yourself with extra income or a lump sum of money , you may still be able to pay down your mortgage without incurring fees. Check with your mortgage broker or your bank to find out the rules attached to your mortgage.
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Mortgage Interest Deduction Limitations
The amount of company interest expenses that can be written off has several restrictions. The section 163 limitation was enacted in 2018 and imposed certain restrictions. This caps a taxpayers deductions for business interest at a maximum of
- 30% of the taxpayers adjusted taxable income for that year.
- The taxpayers business interest income for that year.
- The floor plan financing interest for that year.
Only 30% of all enterprises with average annual gross receipts of $26 million or more during the previous three years are eligible to deduct interest payments. Owners of rental properties who make more than this amount can opt-out of this and deduct all their interest costs annually by including an option on their tax returns. There are other significant tax deductions offered if you own rental property outside mortgage interest.
You can also deduct regular costs associated with running and maintaining the property, including insurance, utilities, advertising, travel costs, and supplies required to keep the place up and maintained. However, you cannot write off costs incurred to enhance the property. You can claim a percentage of these expenses using Form 4562 in the year you completed the renovations or added the furniture to your home. To minimize taxable income, it is vital to emphasize that the mortgage interest deduction is not allowed for investment properties.
Reminder: Interest Only Loans Dont Impact Propertys Depreciation
Despite the fact that the investor isnt paying off the propertys principal, they can still claim depreciation on its structure and assets.
Depreciation is a process of natural wear and tear and is an exclusive tax deduction to owners of income-producing properties, including property investors. Just like interest repayments, depreciation reduces your taxable income so you pay less tax. The key difference is that depreciation is a non-cash deduction so no money needs to be spent to claim it.
On average, depreciation can yield an average first full financial year deduction almost $9,000. To learn more about depreciation and how it can improve your investment propertys cash flow, contact BMT Tax Depreciation on 1300 728 726 or Request a Quote.
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Is It Hard To Get A Loan For An Investment Property
Qualifying for an investment property loan is more challenging because lenders view investment properties as a greater risk. Lenders will want to make sure that you earn enough to afford monthly mortgage payments in the worst-case scenario, such as your tenant stops making their payments.
Compared to loans for your personal residence where you may qualify for a 0% or 3% down program, lenders want to see a larger down payment on investment properties, often between 20% to 35%.
To get the best rates and terms, youll want to get a traditional mortgage, which is why most of our winners here have come from that sector. However, you can max out at four conventional loans for investment properties. If you want to keep going, youll need to convert to private and hard money lenders
Compare Investment Property Mortgage Ratesforcreditin
Investment properties appeal to those who seek to build wealth by, perhaps, flipping fixer-uppers or buying rentals. Find and compare current investment property mortgage rates from lenders in your area.
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About These Rates: The lenders whose rates appear on this table are NerdWallets advertising partners. NerdWallet strives to keep its information accurate and up to date. This information may be different than what you see when you visit a lenders site. The terms advertised here are not offers and do not bind any lender. The rates shown here are retrieved via the Mortech rate engine and are subject to change. These rates do not include taxes, fees, and insurance. Your actual rate and loan terms will be determined by the partners assessment of your creditworthiness and other factors. Any potential savings figures are estimates based on the information provided by you and our advertising partners.
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Bad Reasons For Choosing Interest Only
It is important to look at IO as part of a long-term investment strategy, not just a way of reducing your repayments in the short-term.
Where many borrowers get caught out is when their mortgage reverts to P& I repayments at the end of the interest only term.
This is particularly true for an owner-occupied borrower because the less you pay off the principle amount, the more you end up paying in interest.
Banks know this so they will apply a higher for IO loans than P& I loans and look carefully at your living expenses and debt-to-income ratio.
Over the long-term, interest only will cost you more but you can still generate a good return on investment with the right strategy.
How To Compare Interest
Every borrower wantsthe best mortgage. Heres what you need to do to find the best interest-only loan for you:
- Compare and get a low rate mortgage.Every borrower benefits from a more competitive interest rate because it makes your repayments lower. Of course, its not the only factor you need to focus on, but the best interest-only mortgage for you has a rate thats lower than most.
- Find a loan with the right features.What features you need in an interest-only mortgage depend on your goals and strategy. For example, if you have extra cash lying around , you can use a 100% offset account to save on interest charges. However, suppose youre an investor, and you havean owner-occupier mortgageas well. In that case, you may want to keep your money there instead . In addition, some borrowers benefit from extra repayments, allowing them to repay their mortgage faster.
- Add up the fees.Some mortgages slug you with monthly costs, which can add up to a few hundred dollars a year. Others come with a hefty one-off application charge, while others have no fees at all. So, if you can avoid fees, why not avoid them? Well, if theres a better mortgage for you with a $200 fee attached, it could still be a more beneficial deal than a worse mortgage with no fee. Compare the entire mortgage, not just the charges.
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What Is A Rental Interest
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If youre looking for more financing options to reach your real estate investment goals, a rental interest-only loan helps you qualify for higher leverage and preserve cash flow during times of rental vacancy or destabilization.
Whether youre a new or experienced investor, the life of a rental loan is relatively the same. You take out a loan with set terms and interest rates. Your monthly payments, then, go towards both your principal loan balance and interest, and over time, you eventually pay off your debt.
With a rental interest-only loan, you only pay off the interest each month and initial term, resulting in a lower monthly payment. After the initial interest-only period is over, you will be required to pay the principal and interest for the remainder of the loan term.
Lets take a deep dive into how interest-only loans work and if theyre right for your rental property strategy.
