When you shop around for investment property mortgages you will look to compare interest rates, fees and services just as you would for a home loan. There are however some additional criteria’s you’ll need to take into account because these can have a huge impact on your return on investment.
Lending criteria for Investment Property Mortgages
Most banks will treat loans for investment in single family homes at par with ordinary home loans and charge similar interest rates and fees. They will lend to 80-95 percent of the property value. But if you’re buying an apartment, or investing in a residential property in suburban towns the lending criteria will be far more strict and the lenders will ask you to put in a much higher deposit and may charge you a higher interest rate reflecting the risk.
Lenders including banks will also look at your repayment capacity. Most lenders only include 35 percent of your gross personal income and 75 percent of the gross rental income towards your ability to repay the loan.
In case you do not meet any of the bank criteria’s they will ask you to pay ‘mortgage indemnity insurance’ fee or a ‘low equity premium’. This will add to your cost of borrowing the funds.
Tax on Investment Properties
The main advantage of an investment property mortgage is that the interest on the loan is tax deductible. Few countries extend this facility towards home loans as well.
You may not be permitted deduct the interest for tax purposes incase you rent out your existing home and borrow money to build or buy another home to live in because the purpose of the loan is not to buy an investment property. Similarly you will not be permitted tax deductions if you use the equity on your investment property to buy say a boat or a car.
You must consult your tax advisor because tax laws differ from country to country.
There are lenders, mortgage brokers and tax consultants who have particular expertise in investment property mortgages. It is advisable that you contact the right people and organizations.
How Investment Property Mortgages affects your Return on Investment and Risk?
The larger your loan to equity ration the greater are your returns. In case of increase in property value your returns from the property will magnify many fold. On the other hand you will carry a far greater risk and your equity can get wiped out in case the property values fall.
The other risks you need to consider are loss of rent through vacancy and increase in mortgage interest rates. You will need money from other sources to support any short fall in income from the property.
Some property investors buy properties where the income from the rental property is less than the expenses and mortgage payments. This is called ‘negative gearing’. This occurs in the initial years of the investment. The loss you make in monthly cash flow on the property is partially offset against tax you pay on other sources of income such as your salary or business. Investors are prepared to take a short term loss to make huge profits from capital gains as the property values go up over a period of time.
Interest Only Loans
If you want to buy a number of properties and build a large portfolio of properties then it is advisable to take an interest-only loan. This helps to improve cash flow and increase tax refunds. The money can be used for making improvements to your investment property to increase rents or make deposit to buy more property.
Alternately you can also use the additional cash flow to pay off mortgage on your home loan. This is the first loan that you must clear because you get no tax breaks on these loans. Paying off mortgage on your home loan is one of the best investments you can make with any additional money you may have.
The fundamental principle of investment property mortgages is not pay the principal amount on your loans by taking out interest only loans. But when it comes to your home loan you must try and clear the mortgage as soon as possible and have a debt free home.
If you are nearing retirement then it is advisable to paying off investment property mortgages to reduce your risk and have peace of mind.
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