Financing Options for Property
There are plenty of options out there to finance your next property transaction. Not only from the big four (4) banks and subsidiaries, but also the specialist lenders who focus on certain types of borrowers are delivering a huge range of options to fund your next project.
- Most lenders will provide funds up to eighty percent (80%) of the purchase price for a term of up to thirty (30) years taking security over the title of your property. There are many variables with each different loan including interstate rate, repayment, maturity and default.
- Usually you pay the principal and interest by regular instalments over the term of the loan and in the end you own the property outright. Some factors to consider include:
- Fixed rate – Usually available for one to ten (1 -10) years, this provides you with certainty as to what the repayments will be and locks you into the set rates for the fixed period. You will generally find this is at a slightly higher rate than the variable rate. If you wish to sell or re-finance during the fixed period, you will most likely be up for some break costs. There are also limits on additional repayments during the fixed period. You are protected from any interest rate rises, but do not get the benefit of any interest rate drops.
- Variable rate – This is the standard home loan where you are subjected to interest rate fluctuations leaving you vulnerable to any rises and uncertainty as to future repayments. This is not the best option if you are on a tight budget.
- Interest only payments – Most lenders allow you to pay only the interest on the loan for a limited time. You are not contributing anything towards lowering the debt and you would have to rely on capital growth and future principal payments to pay off your mortgage.
- Split loans– This is where you select part of your mortgage to be fixed and part of it be variable. This can limit your overall exposure to interest rate fluctuation and pay down the principal in a proportionate rate to how the loan is structured.
- Lenders Mortgage Insurance (LMI) – LMI provides the lender with additional financial protection and therefore they may provide loans with only a ten percent (10%) deposit. This can be the factor that assists you purchase two properties with two ten percent deposits rather than one with a 20% deposit. Depending on your circumstances you may wish to buy a portfolio of properties to diversify your assets. However if you are upsizing your home and want maximum return for your dollar, then LMI will be able to assist making every dollar you have saved up count.
- Foreclosure – This is when a borrower defaults on an essential term of the loan contract, usually non-payment for a few months, and the bank takes possession of the property and sells it to recover their losses.
Line of Credit
- Lines of credit can be used as a ‘working account’ to assist in management of cash flow for your investment property portfolio.
- You can use your Principal Place of Residence (PPR) or another property with equity available to run all your investment properties income and liabilities through the one account so it is easy to keep track of all your accounts and any excess is put to good use by reducing interest on the loan.
- If you were to use your PPR, as security, this would eat into your capital growth. It may be wise to ensure your loan is structured to maximise your deductions if you plan on turning it into an investment in the future.
- If you buy a new home before selling your old one, you may need finance to assist in being able to afford owning two or more properties at once.
- Bridging finance is similar to a regular home loan, and you can select whether you want fixed, variable or a combination of both for your interest rate calculation. These loans are usually fairly limited in duration and most lenders will require the bridging loan to be repaid within six (6) to twelve (12) months. These loans often incur a higher interest rate depending on your personal financial circumstances.
- You need to understand how the repayments are going to be structured and what the repayments are going to be. If for some reason you cannot sell your former home, you may end up having to retain the property and rent it out for some time to afford the repayments on the bridging finance loan.
- Often your lender will take security of both properties and you will have one loan to cover your existing mortgage and the new purchase settlement funds. Some lenders allow a six (6) to twelve (12) month repayment holiday for the existing loan, however interest is usually still calculated on the total debt.
- Bridging loans are often limited by the Loan Value Ratio (LVR) of 85% or less. The biggest risk associated with bridging finance is when the borrower has overestimated the achievable sale price or underestimated the associated costs. Bank valuations are often at the lower end of the scale to protect their risk. While Real Estate agents valuations are often at the higher end of the scale so they can entice you to use them to sell your property. Base your calculations conservatively for the best estimate and any extra will be a bonus.
- A reverse mortgage is often used by older homeowners to allow them to access equity in their homes and the loan is repaid when they sell the home or pass away.
- Usually the repayments are minimal or non-existent. Interest is added to the loan each month and the rising balance erodes the equity in the property.
- The home owner is still required to maintain payment of the rates and insurances of the property. Legislation has imposed ‘negative equity protection’ on all new reverse mortgages since 18 September 2012 to protect the bank from ending up with a property burdened by a debt that exceeds its value.
- Interest rates are often higher than average home loans and the compounding debt can rise quickly. It is very important to consider the break costs and interest payable as the projected final payment may diminish your equity to fifty percent (50%) or less in just fifteen (15) years and zero percent (0%) in twenty five years (25) years.
- It is becoming increasingly more common for family members to assist in the purchase of property. A guarantor releases the equity in their own property to be used as additional security for the purchase of another property.
- The new property will be the primary security and the mortgage over the guarantor’s property will support the loan indirectly. If the borrower were to default on their loan over the primary security, depending on the terms of the mortgage, the lender could take legal action not just against the borrower, but also against the guarantor.
- The guarantor would only be liable for the amount specified in the guarantee. Often a parent will put up the equity in the family home to allow a child to purchase a property without saving the full deposit, stamp duty and legal costs that most purchasers require. Using a guarantor can also eliminate the need for LMI.
- An alternate option other than going guarantor is to property share. A parent or family member can purchase a percentage of the property using cash or equity from their home and thereby reduce the LVR for the balance of the purchase price.
- For example, by pooling the total expense of buying a property between family members you increase the borrowing power. You also have a “tenant” who has a fiscal obligation towards the upkeep and maintenance of the property and the pooled finance makes the initial hurdle of saving for a deposit less daunting.
- It is advisable to have a Deed of co-ownership in place to set out the basic rights and obligations of each party and a method for resolving any disputes.
- Construction loans are for people who wish to buy land, or an existing property, and then build a new house on the site. Most construction loans are paid in stages. For example, settlement of the land acquisition, pouring of the slab, placement of the roof, lock up and completion. Construction Loans can also be can be used for renovations, owner builders and subdivisions.
- The use of progress payments means that interest is only being charged on the portion of the loan monies you have used and not the whole of the loan until the stage of completion. Usually the repayments are interest only for the duration of the build to improve the cash flow of the project, however this often incurs a slightly higher interest rate.
- The biggest advantage is being able to borrow against the finished projects value rather than the vacant land or dilapidated property existing on the lot.
Low Doc Loans
- Low Doc Loans have been available for those who do not have traditional proof of incomes such as Small Business Owners, Sub-Contractors, Self-employed or full-time investors. Many of these borrowers re-invest the majority of their income back into their businesses and they don’t have access to financial statements or tax returns that place their income in a favourable light.
- Interest rates are often higher and the LVR is usually capped at eighty percent (80%). This is to protect the lender against the additional risk of providing funds to a borrower who may not have a regular or predictable income stream.
Claire Martin is a Solicitor in the Kreisson Property team.
This communication is sent by Kreisson Legal Pty Limited (ACN 113 986 824). This communication has been prepared for the general information of clients and professional associates of Kreisson Legal. You should not rely on the contents. It is not legal advice and should not be regarded as a substitute for legal advice. The contents may contain copyright.