Different types of loans explained
Unless you’re lucky enough to be a cash buyer, whether you’re a homebuyer or investor, you will need a loan.
There are a lot of loans available from a wide variety of financial providers!
Lenders assess income, expenses, and debt levels to determine borrowing capacity, and each loan type will tailored to suit the borrower’s property goals – for instance, the priority for owner-occupiers is often repayment flexibility and affordability, while investors, usually focus on cash flow, tax efficiency, and leveraging equity.
Here we take a look at the different loans available to both home owners and property investors, and highlight what to consider.
Loans for an investment property
Investment loans are designed for individuals purchasing property with the intention of generating rental income or capital growth. These loans usually come with stricter lending criteria and may have higher interest rates.
- Interest-only investment loans
Common among investors, these loans maximise tax-deductible interest and help improve short-term cash flow. Investors typically rely on capital growth and rental income to offset the lack of equity reduction during the interest-only period. Remember, this type of loan generally only for a set time, and the loan may revert to a principal and interest loan after that, resulting in higher payments.
- Principal and interest investment Loans
Some investors prefer this structure to steadily build equity in their property over time. It may also result in lower total interest paid over the life of the loan.
- Line of credit loans
A line of credit loan allows investors to access funds up to a pre-approved limit, secured against property equity. It’s useful for financing renovations, deposits on new properties, or other investments. However, disciplined use is essential to avoid escalating debt.
- SMSF Loans (Self-Managed Super Fund Loans)
These are specialised loans used by individuals who want to buy property through their self-managed super fund. SMSF borrowing rules are tightly regulated by the Australian Taxation Office (ATO) and typically involve a limited recourse borrowing arrangement (LRBA).
- Fixed and variable investment loans
These loans offer stability or flexibility depending on the borrower’s risk profile. Many investors opt for variable rates to take advantage of offset features and early repayment options.
Loans for a property to live in
Known as owner-occupier or sometimes home loans, these loans are for borrowers who will live in the property they purchase.
There is wide range of loans, and they usually have lower interest rates than other types of loans. It’s worth noting, under the terms and conditions they may restrict you from renting out the property for a period of time.
- Principal and interest Loans
As per principal and interest loans for investment purposes, this is when borrowers repay both the principal and the interest charged by the lender. These loans typically offer lower interest rates and are designed to fully repay the loan over the term (e.g. 25–30 years). For residential loans, it is probably the most common loan borrowers take out.
- Interest-only loans
As per interest only loans for investment purposes, borrowers pay only the interest for a set period (usually 1–5 years). After this period, the loan converts to principal and interest repayments. While this results in lower initial repayments, it does not reduce the loan principal during the interest-only phase, and it may revert to a principal and interest loan after the period of time resulting in higher payments.
- Fixed-and variable rate loans
Much like their investor counterparts, a fixed-rate loan locks in an interest rate for a set period, commonly 1 to 5 years, and provides certainty in repayments. However, fixed loans often have less flexibility, and break fees can apply if you exit early.
Variable rate loans’ interest rates fluctuate based on the lender’s movements and Reserve Bank of Australia (RBA) cash rate changes. They offer more flexibility, such as the ability to make extra repayments or access offset/redraw facilities.
- Split loans
A split loan allows borrowers to divide their loan into fixed and variable portions, offering a mix of stability and flexibility. This can be tailored based on financial goals and risk tolerance.
- Low-Deposit or First Home Buyer Loans
Designed for first-time buyers, these loans may allow borrowing with a deposit as low as 5%, sometimes with support from the First Home Guarantee; these loans often involve Lenders Mortgage Insurance (LMI). There is also other support available for First Home Buyers from the NSW Government.
Other points to consider
- Loan features: Offset accounts, redraw facilities, and portability can provide added value.
- Tax implications: Investment property loans often have tax-deductible interest—consulting a tax advisor is essential.
- LVR (Loan-to-Value Ratio): A high LVR may require Lender Mortgage Insurance and impact approval chances.
- Length of repayment: Some borrowers may prefer a longer payment term (eg 25 or even 30 years), for a lower monthly rate; however, this may result in the borrower paying more in the long run. Also, if you are considering an interest only loan, what’s your plan for when the term finishes?
- Future goals: For an investor, you will need to decide whether you’re aiming to build equity quickly or grow a property portfolio.
We always advise speaking to a financial specialist who can explain what the options are for your financial situation. Always read the small print so you can understand the risks involved, and always ask if you’re unsure or don’t understand anything.
Our aim is to give you information to help you make informed choices. With nearly 50 years of experience behind us, we’re always here for an informal chat to answer your property questions.
Find out more about our property management services and call us on 02 4956 9777, send us an email to mail@newcastlepropertymanagement.com.au or pop into our Cardiff office.