Investment Loans

This is a choice between whether you wish to have the loan balance
reducing by making principal and interest repayments or have the loan
remain at the original level borrowed by only making interest repayments.
Investors are usually advised to take an Interest Only loan, the theory
being that principal reductions on an investment loan are not tax
deductible, so therefore that money that forms the principal repayment
could be used to further invest in another tax advantaged investment,
thereby maximising your tax benefit.

2. Fixed or Variable Interest Rates

This choice is about whether you are comfortable with your loan
repayments fluctuating with interest rate movements. Investors are quite
often advised to select a fixed rate as this ensures a consistent monthly
repayment amount allowing ease of budgeting, so should rates move up your
repayment will not be affected. These days fixed rate loans are not as
restricted as they once were, where many lenders allow some principal
payments to be made without penalty, although in most cases penalties still
exist should you pay out the entire loan whilst still in the fixed period.
Also, most lending institutions have little if any difference in interest
rate between an investor or owner-occupier loan.

1. Standard Amortising 25 – 30 year loan

This is your standard loan that we all have become accustomed to
over the years. You select the term that you wish it to run and decide
whether you would like a fixed or variable rate. Usually the fixed terms
run between 1 to 5 years although a couple of lenders do offer up to 10
years. Quite often you will also have the option of an initial interest
only period of generally up to 5 years. Many investors would have a loan
like this as these have been around for a long time.

2. Line of Credit Loan

As the name suggests this loan is a line of credit, which means the
bank will approve a maximum loan amount against the property that secures
the loan (generally 80% of the value), and you are free to draw this
facility up and down at will. It operates like an overdraft account and
most often comes with a chequebook and debit card for ease of access to
funds. Generally these loans are interest only and have no term attached,
which suits an investor as they are most often advised to get an Interest
Only loan. This loan could be used on the investment property or the family
home or perhaps one on each. These loans have a high level of flexibility
in that you can park money in your loan when it is available and draw it as
required without notifying the bank, as long as you stay within your
approved limit.

3. Multi Account Loan

This loan has a bit of everything and provides the maximum
flexibility of all loans. The loan is set up with sub-accounts so you can
separate your different lending requirements and each account can be
tailored with the features you need to suit the occasion. For example, lets
say Account 1 is your home loan and you might like to have it as a
principal and interest loan with a 3 year fixed rate, Account 2 could be
$30,000 Interest Only line of credit on variable interest and used for say
your share trading and Account 3 could also be an Interest Only Line of
Credit but with a 5 year fixed rate for the investment property. The Multi
Account Loan and the Line of Credit Loan usually have a higher interest
rate than a standard amortising loan – this is a charge for the added
flexibility and complexity.

4. Offset Account Loan

The Offset Account loan is generally not a loan that an investor
would use on the investment property but rather on their family home to use
in conjunction with their investment. An Offset Account loan has a deposit
account linked to the loan, the benefit is that any surplus funds that you
might have, for example rental income, can be deposited into the deposit
account and this is offset against the loan it is linked to. For example,
if the loan amount outstanding is $100,000 and there is $5,000 in the
offset account the interest that is charged on the loan will be calculated
on $95,000. The effect this has is that the home loan gets paid out at a
faster rate because your standard monthly repayment has been calculated on
the full amount outstanding. Offset Account loans vary in the amount that
is offset, meaning that some lenders may offset only 50% of the funds held
in the account whilst others offset the full 100%, so you need to pay
attention to ensure you get the best loan for your needs

The current loan of $24,000 had been set up as a Line Of Credit, which
receives both their salaries. They pay all their living and personal
expenses with their credit card, which has a sweep facility to
automatically clear the credit card every month from their home loan.

However, in embarking on an investment property strategy they needed to
re-define their goals. The original aim was to repay the home loan as fast
as possible to achieve an unencumbered house and to live on the pension.
Tom and Joan now wanted to purchase an investment property for $150,000.
They still wanted to repay their home loan as quickly as possible and keep
their cash flow situation as it was, but also wanted to be able to keep
buying investment properties to create wealth.

From a lending point of view, this represented a number of conflicting
requirements that required a variety of loan products.

We settled for a discount variable rate home loan with principal and
interest repayments, combined with an offset account. The investment loan,
also at a discount variable rate but on interest only for five years was
coupled with a line of credit.

This arrangement had the further advantage of clearly distinguishing
between personal and investment loans, making it easier for Tom and Joan’s
accountant to identify and claim expenses.

How did this work?

Firstly their existing Line of Credit was converted to a Principle and
Interest housing loan of $24,000 taking advantage of the bank’s
introductory discount rate. All income, including rental payments and
salaries were directed to the offset account. Personal expenses continued
to be met from the credit card and cleared monthly from the offset account.

This now meant that not only was the housing loan reducing, but the
reductions were even greater. This was due to the combination of a cheap
introductory rate along with the benefits of the offset account reducing
the principal from which interest was calculated by the amount of both Tom
and Joan’s salaries together with the rental income, before funds were
required to clear the credit card each month.

We then established an investment loan of $160,000 to purchase their
investment property of $150,000 purchase price plus meet all the purchase
costs. This had the advantage of not requiring Tom and Joan to contribute
any cash funds to complete the purchase. It also meant that a larger
portion of interest could be claimed as a tax deduction and returned to
them as less taxation being deducted.

As there was still ample equity in the family home we set up a Line of
Credit of $80,000 to enable them to fund the purchase of another investment
property once they were ready. Now they could look around for a second
investment property secure in the knowledge they could pay a deposit
immediately. They could then put forward a loan application based on the
full purchase price plus costs using the equity in the new investment
property.

This structure gave Tom and Joan peace of mind as it only marginally
changed their personal cash flow arrangements whilst maximising their
ability to repay the housing loan, purchase an investment property with no
cash outlay and provide for future investment property purchases. In
addition, due to the level of borrowing and income, we were able to have
most of the normal fees and charges waived.