If you’ve been making the most of the low-interest rates to pay off your owner occupier loan, you must have probably built significant equity in your home.
Many home owners leverage this equity and refinance to a lower interest rate. This allows them to take a loan for an investment property that earns them rental income.
In fact, as per ABS data, in May 2022, the value of new loan commitments (seasonally adjusted terms) for investor housing increased 0.9% to $11.2b, after a fall of 4.8% in April.
Nonetheless, before diving in, get all the relevant information and then decide if refinancing your home loan can help you reach your investment goals.
How Does Refinancing a Home Loan Work?
Since taking out your home loan, things may have changed, including your financial situation. If so, it may be time to refinance.
Refinancing your home loan means taking out a new mortgage to repay an existing loan. It usually involves switching lenders or institutions, but it's not a rule.
Refinancing is often seen as a pathway to improve one's financial position as you can save thousands from a lower interest rate, more accessible repayment terms, and/or better loan features.
Nonetheless, if you refinance your existing mortgage with a new lender, they will treat it as an entirely new loan, and you may need to get your property valued.
"If you're actively looking to refinance, you should ideally study the offers by different lenders and compare suitable home loans, including the comparison rate. You can easily access this information online," adds Graeme John, Head of Growth at Joust.
Our blog on the pros and cons of refinancing offers you insights about refinancing and its implications in the long term.
How Much Equity Do I Need to Refinance?
For starters, try to put at least 20 per cent of your investment property’s value as a deposit. This will help you avoid Lenders Mortgage Insurance (LMI) and increase your bank’s confidence in offering you finance.
When you refinance your existing loan, your useable equity is typically around 80 per cent of the value of your property minus your balance debt.
For example, if your property value is $1,000,000 and you owe $350,000 on your existing home loan:
- Your lender may allow you to use $450,000 towards purchasing your new home (or investment property), even without LMI.
- The $450,000 is basically the difference between 80% of your total loan ($800,000) and the balance owed ($350,000).
In some cases, you may be able to borrow up to 95 per cent with LMI. However, this is less common.
Most lending specialists won’t allow you to borrow the property's total value. This is a precautionary measure in case market prices drop and your loan exceeds your house value.
If you’re considering refinancing to buy an investment property, it is advisable to seek professional advice about the tax implications based on your loan structure any loan. This is because you may not qualify for tax benefits if you use your existing home as security and place both properties on the same loan. Learn how equity works when buying a second home.
If You Don’t Have At Least 20% Equity
The main drawback in refinancing without at least 20% equity is that you’ll likely have to pay for Lenders Mortgage Insurance (LMI). Depending on the loan size, this could be many thousands or tens of thousands of dollars and outweigh the benefits of refinancing.
For instance, if you’ve built up $100,000 in equity on a home worth $700,000 (i.e. 85.71% LVR), your LMI premium could cost around $6,600 if you’re an owner occupier.
Nonetheless, study the difference between your old home loan interest rate and refinanced interest vis-a-vis the capital gains on the property. It can help you decide whether to refinance with lesser than 20% equity.
If you're still keen to explore this route, read everything you need to know about LMI to be more confident when taking out a loan exceeding 80% of your property's value.
Also, note that if you have paid LMI on your original home loan, it’s unlikely to be transferred to the new loan. However, depending on your lender, you may be able to secure a rebate on your LMI if your home loan is over two years old.
How to Refinance Your Existing Home Loan
If you want to buy an investment property while leveraging usable equity in your owner occupier home, refinancing can be a way to access suitable investment loans.
The process would typically include the following components:
- Refinancing your Home Loan: Refinance your current loan to a lower rate loan, which offers you a better deal such as offset account and redraw.
- Leveraging Equity: Draw up some of your useable equity as a deposit on your investment property.
- Take out an Investment Loan: Apply for an investor loan to cover the rest of the amount and begin paying off the home loan at the new rate along with your investor loan.
Refinancing to a Fixed Rate Home Loan
In a scenario of rising interest rates, when you refinance your home loan, you could opt to lock in low interest rates.
Refinancing to a fixed rate will also help you manage budgets more effectively and steadily build your investment property equity, regardless of the interest rate movement.
Benefits of Refinancing for Investment Property
Many Australian home owners view refinancing as an excellent way to purchase investment property because of the following advantages:
- Access to equity: Owner occupiers have successfully used refinancing to buy an investment property. Refinancing enables access to the equity of your own home, which can then be used as a deposit on your investment property.
- Lower interest rates: If you're considering a move to buy an investment property, your other credit, such as your car loan and credit cards, will lower your borrowing power. In this scenario, refinancing existing owner-occupier loans is a great way to reduce interest repayments and free up cash to add to your useable income.
- Build wealth and your investment portfolio: Taking a new loan for your investor property on top of your loan will increase your debt. However, renting out the investment property will help you earn income. The rental income should cover a significant portion of your investment loan repayments. Moreover, as your property value increases, it will help you make capital gains in the long run.
- Low risk and tax benefits: Property investment is generally viewed as a relatively stable option as compared to investing in shares and cryptocurrencies. Property investment is tangible and straightforward and has benefitted many investor buyers in Australia. In addition, you can claim tax deductions on a range of investment property expenses.
Even if you don't buy an investment property, refinancing from variable to fixed is a great way to insulate yourself from potential future rate hikes for your specific fixed term. Likewise, by consolidating debts into a new lower-rate home loan, you can reduce your monthly repayment expenses overall.
Risks of Refinancing for Investment Property
Refinancing to invest in property can be an excellent opportunity to meet your financial objectives. Nonetheless, it's not without its share of risks. Here are some points worth pondering over before advancing with your plans:
- Refinancing costs: You'll potentially have to incur additional expenses such as discharge fees for your existing loan, establishment fees for the new loan, break fees if you're switching from a fixed rate loan, etc.
In addition, since it's a property purchase, you’ll have to be prepared to shell out for stamp duty, legal fees, council rates, property maintenance, etc., and potentially land tax too.
- Failed application: Lending criteria vary. Your lender will assess the risks associated with you borrowing for an investment property. Several factors will be considered. This includes low property value growth over time or unstable income that leads to defaulting on your loan.
Your application for refinancing could also be rejected if your lender finds the amount requested very high risk. Again, this could affect your credit score and your future borrowing capacity.
- LMI costs and increased debt: To obtain finance, you typically need to show a deposit of at least 20% of the purchase price of the investment property. If you cannot, the high cost of LMI may outweigh any benefits from refinancing.
Moreover, refinancing your home loan to purchase investment significantly increases your debt. By accessing your equity, the original loan gets more extensive, and you have the investment loan to pay as well.
- Unoccupied rental property: There could very well be times when you cannot find a tenant for a few months. In this case, you'll have to pay for two mortgages simultaneously each month without the support of rental income.
- Lower than expected rental income: If price growth is restricted or there are no takers for your property, you may not earn sufficient income to manage your home loan repayments.
In sum, if you're unsure how to proceed, seeking professional financial advice will help you plan more confidently.
What to Consider Before Refinancing
We put together some critical considerations before refinancing for an investment property. Here's a quick look:
- Survey the market: Study the refinance deals offered by different lenders. Look for lower interest rates, relevant features such as offsets and redraw, as well as costs such as LMI when you refinance. Refinancing your loan will include some initial costs, but switching to a low rate lender usually helps save money over time.
At the same time, don't blindly opt for a loan with the lowest interest rate in the headline. Instead, keep your financial goals in mind when deciding if now’s the right time to refinance – and which lender may be better for you.
- Choice of lender: When refinancing your home loan to buy an investment property, you can either stay with your existing lender or move to a new lender. Ensure that your new lender has a valid Australian Credit Licence. Take time to understand the terms and conditions of each lender and seek clarity on aspects you are unsure of.
- Expected rental income: Thoroughly research the property market so that you buy in a location with demand for rental properties. In addition, look for areas with property price growth potential to help you make capital gains.
What is the Best Way to Finance a Second Home?
If you're not in favour of refinancing, you could finance your second home purchase in other ways. These include:
Line of Credit
Where you've built good equity in your own home, you could use a line of credit loan for a substantial chunk or all of your deposit. You'll have to pay only the interest portion of the loan until you reach your credit limit.
You can utilise your credit limit per your wishes and pay interest only on the amount you use. The interest-only repayments help in maximising your tax-deductible debt.
On the other hand, the interest rates may be higher, and you'll be using your own home as security against an investment property, thus increasing your risks.
Moreover, you could end up repaying multiple loans, including your home loan, the line of credit and your investment loan. In addition, as interest accrues to your line of credit limit, you'll eventually pay more interest over time.
You could also use the money in your offset account to finance your second property purchase.
While paying off your home loan, you may also be putting money into the offset account attached to your home loan. This account may now have accumulated substantial savings. You can use these funds towards the deposit and, if possible, stamp duty on your second home.
Click here for more details about offset accounts and how they work.
Joust for your second property
Buying an investment property is a milestone event for every home buyer. Refinancing, if done right, can get you closer to achieving your long term property goals.
Our Instant Match is a free, user-friendly and secure online tool that instantly matches with three of our trusted lenders. In addition, it enables you to access competitive rates based on your requirements in a few clicks.
While there's no obligation to proceed, it may interest you that home buyers have managed to save an average of $3,348 each year when using Joust! You can learn more about Joust here.