Investment Loans for First Time Investors
March 4th, 2014
If you’re a first time property investor and were overwhelmed by the numerous types of investment properties on the market, then brace yourself – there is more than double the number of investment loans and loan features to squander through as well.
When selecting an investment loan, it is most important that as a borrower you are fully aware of the concept, structure and any features associated with the loan before undertaking it. With this sort of information in hand, you can be certain your loan delivers the best foundation for your investment strategy. Four of the most common loans taken on by first time investors are explained in brief below.
Please note that this article is tailored towards first time investors, and should be referred to as a guide only. CBS Property Group strongly recommends you seek further professional advice should you be looking to secure an investment loan.
Interest Only Loans
What is it? For interest only loans, the borrower only pays the value of the interest accrued on the principal value. For example, say the principal value of a loan is $200,000 and the interest rate is set at 6 percent. After the first year, you would only owe the interest gained, which is $12,000; rather than $212,000 as calculated for a standard variable loan (sum of the principal and interest values).
In theory, interest only loans are never completely paid off since no payment is actually made towards the principal value. This means as a borrower, you gain no discernible equity through repayments as otherwise seen with a standard variable loan. Instead, investors gain equity by investing in a property and trusting in the value of that property. In other words, your equity only grows if the value of the invested property increases over time.
Often interest only loans are drawn down over a normal term (e.g. 25 years) with the interest only period extending for 1 to 5 years. For most investors, it is appropriate to sell after this time, however most lenders are open to negotiating further extensions to the interest only period if the standard time is not suitable.
Advantages? Monthly repayments for this type of loan are much lower in comparison to standard variable rate loans since you are only paying back the interest gained on the principal value.
Disadvantages? It is possible to both lose money and gain no equity in a property with this type of loan.
When should this loan be considered? These loans are a sure sign of success if you are certain the value in your investment property will increase, maybe due to known local developments or planned renovations. Such loans can lead to substantial capital growth in a short to medium period (1-5 years).
Introductory Rate Loans
What is it? Undressed, this is a standard loan with an initial (commonly referred to as ‘honeymoon’) period where much lower interest rates are offered. The introductory rates fluctuate according to the Reserve Bank, but are generally set around 4.5 to 5 percent, compared to the standard loan rates that are set around 6 to 7 percent. The honeymoon period depends on the lender, but usually extends from 6 to 12 months
Advantages: The biggest plus is the initially savings gained with lower monthly repayments. These types of loans are also very flexible, allowing you to pay extra off the loan at any time.
Disadvantages: Once the honeymoon phase is over, the loan will roll over to a standard variable rate loan with monthly repayments valued at the normal interest rate. Always be aware of the extra payment required for this period, as well as any exit fees associated with this loan.
When should this loan be considered? These loans are ideal if you’re intending to live in your investment property, whether it be to save on the DIY renovation or for your own intentions.
Line of Credit/Equity Loan
What is it? This is usually a pre-approved loan which can be either progressively draw down or drawn down in its entirety throughout its term. In this context, pre-approved usually means the lender feels the borrower is credit worthy and can access the loan when required. Investors typically gain this pre-approved status by offering some sort of security for the loan (i.e. line of credit), whether it be another investment property or their primary place of residence. This line of credit is collateral for the lender, should the investment fail.
Advantages? Like introductory rate loans, these types of loans often tend to be more flexible with regards to repayments and redraw features. If you draw down the principal loan in stages, then you are only required to pay interest on the outstanding balance. These loans also offer much lower interest rates since you are already risking the equity in the property offered as credit.
Disadvantages? Be prepared to possibly lose all or a portion of the asset you put up as security if the investment takes an unexpected turn for the worst. Often an annual fee also accompanies these types of loans.
When should this loan be considered? Line of credit loans are useful for those who like to have the money ready to throw at the next property bargain. They are also suited to investors who wish to consolidate their property investment loans into one, with a lower interest rate.
What is it? The whole point of a construction loan is that you can progressively draw down the loan as required during the construction phase of a property. Like a line of credit loan, interest is only paid on the balance outstanding at the time, rather than the entire principal amount drawn down.
Income from a construction loan is staggered, typically with 5 to 6 preset drawdowns. The number of drawdowns is usually negotiated between the borrower and lender during the initial planning stages of the loan. Each draw down marks a new phase of the construction process, e.g. roofing or furnishings.
Before the next draw down can be accessed, it is often the case that a representative from the lender must inspect the property. The purpose of this is so the lender can verify the previous phase is complete, and the income provided by the new draw down will be directed towards the next building phase as planned.
Advantages? Save money by only paying interest on the outstanding balance as you need it, rather then the entire principal value of the loan. Most lenders will generally lend between 60 and 90 percent of the land value for construction loans.
Disadvantages? To gain approval from your construction loan, most lenders require a copy of any council approved building plans and quotes. Tracking down this information can be tedious task for some.
When should this loan be considered? These types of loans are only appropriate if you’re thinking of building a residential or commercial property from scratch.
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