Real estate is one of the most stable and secure ways to make money as an investor.
The catch? You usually need a large amount of savings and plenty of cash in the bank to secure an investment property.
That’s why it's so important to get your head around investment property financing before you secure your first rental property. This will help you pick the right property type and loan option for your needs and ensure you’ve got a savings buffer in place before you make a purchase.
Are you worried about losing money or not making money from your investment property? Keep reading to discover the must-know investment property financing basics and financial planning basics you need to know as an investor to make a smart, informed investment decision.
How does investment property financing work?
Before we dive into specific tips and tricks for investment property financing, let’s explain how buying an investment property works from a financial point of view.
As an investor or buyer, you have a few key ways to fund your property purchase: you can save up thousands of dollars for a deposit, you can draw on the equity in your current home or property, use a money gift from a family member or even buy your property through a trust.
In most cases, first-time investors will draw on their savings to pay the deposit (usually 20% of the purchase price) on a property and then use a home loan to pay off the rest of the purchase price. However, seasoned investors or homeowners are more likely to draw on the equity in the current property to pay for the deposit.
Investment loans vs owner occupied loans
No matter how you pay for the deposit, every investor will need to take out a specific kind of loan, known as an investment property loan.
As the name suggests, the main difference between these two types of loans is the purpose of the property purchase:
- Investment loans are taken out by property investors who plan to rent out this property in exchange for rental income.
Generally, these loans are seen as ‘riskier’ in the eyes of banks and lenders (as the rental market is unstable and can come with the risk of vacancy). That’s why these loans tend to come with higher interest rates and fees.
- Owner occupied loans are taken out by borrowers who are buying this property with the goal of living in it as a home.
Loan approval explained
Before you take out an investment loan, it’s important to understand the different types of loan approval and what they mean for your investment journey.
- Pre-approval (also known as conditional approval): This means that a bank or lender has agreed (in principle) to approve your loan request, on condition that your income remains the same. It is not a loan guarantee and is typically valid only for 3 months, but it's important to secure one if you want to buy at auction.
- Unconditional approval: This formal approval guarantees that your lender will honour your loan request unconditionally. To obtain this kind of approval, your lender will need to thoroughly assess your investment plans and suitability for the loan.
While the process of applying for investment loans is similar to owner-occupied loans, you will need to supply a few extra details to your lender. First, you’ll need to be able to show the potential rental income for the property you want to buy and how likely the property is to grow in value.
Plus, you’ll need to be conscious of the loan-to-value ratio (LVR). Lenders see investment loans are riskier than traditional home loans, so you’ll only be approved with a lower LVR (meaning you’ll need to save up a larger deposit or pick a property with a lower sale price).
Types of loans for investors
Along with standard Australian property investment and financing loans, there is a range of specialised loans to help investors secure a property, no matter their needs or circumstances.
- Low-doc loans: this type of loan is designed for buyers or investors who are self-employed or don’t have all the income details required for a standard loan.
While you will need a larger deposit (usually over 20% of the purchase price) and you will likely be hit with a higher interest rate, this can be a good option if you don’t have a standard source of income or have recently started your own business.
- Bridging loans: found the perfect investment property, but haven’t sold your current property to fund it? A bridging loan can be a temporary solution to help you avoid double mortgages and help you act fast to grow your property portfolio.
- Construction loans: if you’re looking to renovate your existing investment property or build a new investment property, this type of loan can help you access a line of credit to fund this build.
Typically you’ll be paid lump sums of money in instalments, aligned with construction milestones (like laying the foundations, putting up the frame and adding fixtures and fittings).
How much of a down payment do you need to buy a house or investment property?
As we mentioned, banks and lenders tend to see investment loans (whether they’re residential or commercial property finance) as riskier than traditional home loans. So you’ll need to save up a full 20% deposit (a.k.a. 20% of the property’s sale price) to avoid extra fees and charges (like Lenders Mortgage Insurance).
In case you haven’t come across this term before, LMI is a type of insurance used to protect banks against borrowers who might default on their loans. If you have less than a 20% deposit, you’ll need to pay LMI (which can add up to thousands of dollars).
Instead, it’s worth assessing your loan to value ratio (LVR, usually shown as a percentage) and ensuring this is below 80%. In general terms, the bigger your deposit, the lower your LVR.
LVR is linked to risk. The lower your LVR the less of a risk you are to the bank, which means you can score a better interest rate and lower repayments, too.
Best ways to borrow money for an investment property
Now that we’ve covered the way investment loans work, let’s dive into what you need to know about investment property financing. First up, let’s look at the different ways you can structure your loan and the best ways to borrow money for an investment property.
In the majority of cases, an investment loan is necessary to purchase a rental property. While paying interest is unavoidable, you can find ways to reduce the amount of interest you need to pay over the lifetime of your loan.
To help you get the best deal, here’s what you need to know about the different loan structures:
- Fixed interest loans: these loans allow you to lock in an interest rate for anywhere from one to five years.
Pros: you know exactly what your repayments are going to look like for a set period of time and may be shielded from interest rate rises during your fixed period.
Cons: you don’t have any flexibility with your loan and may miss out on savings if interest rates drop during your fixed period.
- Variable interest loans: these loans allow your interest rate to rise and fall with the market.
Pros: you’ll reap the benefits of low-interest rates (when they happen).
Cons: your repayments may change from month to month and will increase if interest rates go up.
- Principal and interest loans: these loans involve paying off the original loan amount and interest at the same time.
Pros: you’ll pay less interest over the life of your loan, repay your loan sooner, build equity in your property faster and may score a better-interset rate, too.
Cons: you’ll need to budget for higher repayments and may run into financial stress if your property is vacant or you’re managing other debts.
- Interest-only loans: these loans allow you to only pay back the interest portion of your loan, for a set period of time (usually one to ten years).
Pros: you’ll score lower monthly repayments for a set period of time.
Cons: you’ll likely pay more interest over the life of your loan and you won't be building equity in your property during your interest-only period.
If you’re looking for the best way to borrow money to purchase an investment property, it’s worth taking out a principal and interest loan that allows you to save in interest and build equity as soon as possible.
How to buy a house with no savings (or little savings)?
Another hot topic when it comes to investment property financing is how to buy a house with no savings. If you think you need a large deposit to secure a rental property, think again.
There is a stack of practical ways you can fund your property purchase with little money and without saving thousands of dollars for a deposit, including:
- Access a guarantor loan: if a family member is willing to guarantor your loan, they can put up their property as security and allow you to make a purchase with a small deposit.
- Look for properties in affordable areas: rather than sticking to competitive inner-city or capital city markets, why not look further afield to rural or regional areas that are rising in popularity? There are still pockets of affordability in these areas that you can capitalise on.
- Using equity to fund your next property purchase: if you already own a home or property, you can draw on the value (equity) in your current property to help fund your next property purchase.
- Consider a fractional property investment approach: this approach allows you to pool your money with other investors to buy shares in a simple property, making it a flexible, low-cost way to get started as a property investor.
How to plan for an investment property purchase
Along with investment property financing, you need to make sure you’ve got your personal finances in order before starting your investment journey.
The more preparation you do ahead of time to get your money and finances in order, the better off you’ll be in the long run.
So here are a few key financial planning steps to take before securing your first investment property:
Save up a decent deposit
Are you wondering how much to save to buy a house? Having at least 20% of the property price saved up as a deposit is a practical way to avoid extra fees like LMI. Plus, make sure to give yourself a buffer of 5-10% of the sale price to cover additional costs (such as renovations, repairs, maintenance, legal and conveyancing costs and pest control).
Give yourself a cash buffer for unexpected expenses
Wear and tear are inevitable in every rental property. Put yourself in a good financial position by having a ‘sink fund’ of a few thousand dollars that can be put towards unexpected accidents and emergency repairs to avoid eating into your returns or rental income.
Plan out a budget for repairs and maintenance
Make sure you’ve run the numbers and calculated how much you should expect to send each month and year on maintenance and repairs. This will help you set a maintenance budget for your property so you’re never hit with expected bills.
Work with a professional to set the right rental price
Setting the right rental price is key to attracting good tenants, keeping them around for the long term and ensuring you’re generating a good rental yield. By working with an experienced property manager, you can ensure your rental is priced competitively and is able to earn you enough money to generate passive income, too.
When it comes to investment property financing, knowledge is power. By understanding your loan options, understanding how to reduce your expenses and boost your returns, you can make a smart investment decision.
Whether you’re a first-time investor or growing your portfolio, smart financial planning and proactive budgeting are key to keeping your rental profitable and generating a strong rental yield for years to come.
Like what you just read? Well, there’s a lot more where that came from
Subscribe to our FREE monthly newsletter for the best property content on the internet!
Disclaimer: The information provided on this blog is for general informational purposes only. All information is provided in good faith; however, we do not account for specific situations, facts or circumstances. As such, we make no representation or warranty of any kind whatsoever, express or implied, regarding the accuracy, adequacy, validity, reliability, availability or completeness of any information presented.
This blog may also contain links to other sites or content belonging to or originating from third parties. We do not investigate or monitor such external links for accuracy, adequacy, validity, reliability, availability or completeness, and therefore, we shall not be liable and/or held responsible for any information contained therein.