Finance Investment Property
When preparing to build a development the first step is to identify how much you can afford to borrow (if you require to) and as such organise the correct financing options for you. This process can be a little tricky and is more than just asking the bank for the figure you require to purchase.
If this is your first home that is being built, the amount you need to borrow has the potential to be more than the balance of your house minus the deposit that you have facilitated. Yes, other costs like stamp duty, lender’s mortgage insurance and other fee’s need to be taken account of.
The bank’s willingness to lend money is another question…This will depend on how much you will be able to pay back, over a given period of time. The bank also evaluates the potential risk they’re being exposed to in regards to your ability to repay the loan they provide. As the person that is submitting the loan, you should also carefully consider what is a realistic for you to pay in repayments, as they will have an effect on your lifestyle going forward.
What is Lenders Mortgage Insurance (LMI)?
Lenders Mortgage Insurance is an insurance that helps protect lenders from client’s defaulting on loans. In Australia you’re required to pay for Lenders Mortgage Insurance if your deposit falls under 20% of the purchase price of the property you’re buying or building on
Risk is a very important factor for lenders and as such this insurance is what allows them to offer amounts that are in some areas 95% of the purchase price of the property
The amount of Lenders Mortgage Insurance you’ll need to pay will depend, among other things, on the size of the deposit you have to begin with.
When is Lenders Mortgage Insurance needed?
As previously discussed this could be required due to the deposit on the property being less than 20% of its total value.
People who are self-employed may also need to apply for something called low doc loan (short for ‘low documentation’). In this case, Lenders Mortgage Insurance is likely to be required for a mortgage even if the loan’s for only 60% of the value of the property being bought.
How is Lenders Mortgage Insurance paid?
Lenders Mortgage Insurance is usually paid up front when you’re arranging the loan, this is often taken as a part of the amount that’s drawn for your mortgage.
An example of this, say your loan is $500,000 and the insurance premium for the LMI is $5000, your mortgage would become for $495,000, as the extra $5000 is being contributed to your LMI
Lenders Mortgage Insurance can be on a certain loan until the value to ratio (LVR) is reached – for example, 70% of the market value of the property.
How to avoid paying Lenders Mortgage Insurance
The two possible methods of avoid Lenders Mortgage Insurance is
- Find someone that will act as a guarantor
- Have 20% deposit on the purchase
Variable vs. fixed interest loans
When obtaining a mortgage, you will have to pay interest back to the lender on top of what you have borrowed. There are a couple of different ways in which interest is calculated……
How do fixed interest home loans work?
A fixed interest loan is exactly that – a loan where the interest rate that’s charged remains the same for a period of time agreed by the individual taking out the loan and the lender. This period can be anywhere between 1 and 30 years. Once this time expires, you will most likely go to a variable interest rate unless a prior arrangement has been made.
Having a fixed interest rate provides CLARITY, a certainty of knowing the repayments that are required and protects you against rising interest rates. This can either be a positive or a negative, if the interest rate drops your loans interest rate will not as it is “fixed” so like any decision this needs to be carefully deliberated.
How do variable interest home loans work?
A variable interest rate mortgage is a type of loan where the interest rate that you’re charged can fluctuate solely on the cash rate which is set on the first Tuesday of every month by the Reserve Bank of Australia.
Should I choose a variable rate or a fixed rate?
The difference of a variable rate and a fixed rate help’s individual identify which is best to suit them. What’s right for you will depend very much on individual,
- The size of your mortgage
- Duration of the loan
- Most importantly the prevailing interest rate and the state of the economy.
Which choice is right?
When interest rates across the market are low but an increase is expected in the short term, the more suitable option would be a fixed rate loan. If interest rates continue to rise, a fixed rate loan can help to protect you and avoid future rises. However, if interest rates are projected to go down it would be more suitable to establish a variable rate loan and take advantage of the lower rates being offered, this compared to being fixed. A variable rate loan has greater flexibility than a fixed rate loan as the names may suggest, this is because repayments can vary and you can repay more off your loan if you have the ability to do so. A fixed loan does not allow additional repayments off of the principal.
Equity and what it is
The easiest way to think of equity is to say it’s the portion of your property that you currently ‘own’.
How to calculate your equity
Equity on your property is the current market value of the property, minus the amount of the mortgage that is still owed to the bank.
Property value – outstanding loan amount = available equity
So if your house is worth $700,000 and you still owe $300,000 to the bank:
$700,000 – $300,000 = $400,000 (your equity)
Using equity to buy an investment property
Let’s say there is a mortgage on the home you live in, if you’ve built up enough equity on it you can use it on another mortgage for an investment property.
In many cases you can access anywhere up to 80% of your equity to use as a deposit on an investment property. Well worth investigating if you’ve created enough equity and are interested in an investment property!
Loan serviceability is known as the ability to meet loan repayments as calculated by the lender.
How is loan serviceability assessed?
There are several factors that are taken into account to judge serviceability. These include personal financial factors, including total income from all sources, how much you spend per month, and all of your other outstanding liabilities such as credit card debt that you may have.
Once a total sum of these is identified, the lender will calculate a cash surplus per month which is then used to determine serviceability of a final loan amount.
Hopefully the role financing in developing your investment property makes a little more sense. If you have anymore questions feel free to get in contact with the team at Arlington Homes and we will aim to assist you!
*all information provided by Arlington Homes aims to assist and support your knowledge gathering for areas surrounding building. For more specific questions, please consult a Bank.