Refinancing your investment property loan

The number of people refinancing recently hit a record-high, with historically low interest rates and cashback offers driving people to find themselves a better deal. As an investor, refinancing might be a good move to ensure you’re making the most of your money. That’s the goal, right?

The process of refinancing your investment property is pretty similar to refinancing any other loan. But as an investor, you could end up reaping more tax benefits than the average owner-occupier. Regardless, there are quite a few things to consider before deciding to make the switch.

What is refinancing?

Refinancing is the process of changing from one mortgage to another one, likely because you’ve found a different mortgage with a lower interest rate, fewer fees, better loan terms, or other features/perks that caught your eye.

There are two types of refinancing: internal refinancing and external refinancing. When you internally refinance, you switch to a different mortgage with the same provider. When you externally refinance, you switch to another mortgage with a different lender.

Sometimes, letting your lender know you’re looking to refinance can spur them to offer you a better deal. People might opt for this type of refinancing if they still have other financial products with their mortgage provider, like an accompanying bank account or other loans they’re still paying off. Internal refinancing might be the easier, less complicated answer to your mortgage debacle.

Alternatively, people might look elsewhere for a better deal on their home loan. There is absolutely no shortage of mortgage providers in the market, so your options are plentiful. If you aren’t chuffed with your current lender, external refinancing might be more up your alley.

What is home equity?

Your property’s equity is the difference between its value and how much is owing on the mortgage. Basically, it’s how much of your property you actually own, which is where its value to you lies.

For example, if you purchased a property for $500,000 with a $400,000 mortgage, your home equity would be $100,000 (this is 20% of the home’s value; the amount you’d need to put down as a deposit to avoid paying lenders mortgage insurance).

If after ten years, your home’s value went up to $650,000 and your mortgage went down to $300,000, you’d have $350,000 in equity.

Essentially, your equity goes up when your home’s value increases or your mortgage balance decreases. Instead of leaving your home’s equity untouched, many people choose to refinance their mortgage to use the stack of cash tied up in their home for other ventures.

Refinancing an investment loan

Owning an investment property is a common way many Aussies choose to invest their money, typically to rent it out or renovate to sell. Regardless, in most instances, owning an investment property is a strategy to grow wealth.

If you have had an investment property for some time, chances are you’ve raised some equity in the property. By refinancing, you have the chance to unlock some of this equity to spend on things like renovations, buying another investment property, or even investing elsewhere. Alternatively, you might have found another mortgage with a lower interest rate, or other perks you don’t currently have like an offset account, which could end up saving you money in the long run.

Either way, refinancing an investment loan can end up being a good way to make the most of your investment. Of course, there are personal considerations that will come into the mix when deciding if it’s right for you, like whether you have enough equity or whether you’ll experience any hassle breaking your mortgage.

Pros and cons of refinancing an investment loan

As with anything, there are pros and cons to refinancing your investment loan that should be considered before you jump the gun. The benefits can be great, but do they offset the potential drawbacks? Both sides of the coin should be considered before you decide whether the risks outweigh the rewards.

To get a better idea of what refinancing an investment loan might look like for you, let’s quickly outline some of the notable pros and cons that might impact you.

Now that we’ve listed them above, let’s expand on a few to get a more comprehensive understanding of refinancing an investment loan.

Pros

Securing a lower interest rate can be a highly beneficial outcome of refinancing, but obtaining a lower rate might depend on your personal circumstances. Typically, factors like your loan-to-value ratio (LVR) and your credit score will determine whether refinancing ends up being a good deal. Generally speaking, the higher the LVR, the ‘riskier’ you are considered by the lender, so you’ll usually pay more in interest charges. A lower credit score could also make it harder for you to qualify for a lower interest rate.

Additionally, while unlocking the equity in your home to spend on building your wealth can be a great strategy, it comes with risk depending on what you do with it. If you choose to renovate, chances are you’ll increase the value of your asset, therefore building more equity (if you renovate right). Alternatively, choosing to invest the unlocked equity in the stock market could be advantageous, but you risk losing the money if the market crashes. Plus, you need to pay it back eventually, so using your equity is by no means free money.

Refinancing as an investor does give you the ability to make tax deductions that aren’t afforded to owner occupiers. Some of the major costs of refinancing can include application fees, legal costs, lenders mortgage insurance (LMI), stamp duty, loan registration costs and the discharge fees of leaving your current mortgage. These costs can be claimed on your tax returns incrementally over five years or the loan term, whichever is shorter. If you sell or refinance in this period, you can claim the deductions all at once. You’ll still be able to claim the ongoing costs of the investment (e.g. interest, depreciation) after you refinance.

Cons

Unfortunately, refinancing isn’t free. This is why it’s important to weigh it up before switching to a new mortgage; it should be worth it after you’ve paid the fees. If you’re switching to a slightly better interest rate, but you have to pay a handful of fees and charges, you should do some calculations to see whether you end up better or worse off after it’s all said and done. The cost to refinance can vary depending on whether you’re switching to a better interest rate, switching products with the same lender, or switching to an entirely new lender. To give you an idea of the costs involved to refinance, here’s a snapshot:

• Loan application fees (particularly if you refinance to another lender)

• Discharge fees

• Settlement fees

• Break costs (if you refinance within a fixed loan period)

• LMI (if you refinance above 80% LVR)

If you haven’t built up enough equity, refinancing may not even be possible. Plus, refinancing above an 80% LVR means just another expense, LMI, which can be quite costly. Refinancing might also mean breaking your fixed-rate loan period, resulting in break costs, which can be pretty expensive. All in all, refinancing might not be worth it if you haven’t raised enough equity, you’re still under a fixed-rate contract, or if you aren’t going to reap the benefits at the end of the day.

How to raise equity in your investment property

There are a few standard ways to raise equity in a property (e.g. make extra repayments or use an offset account). But if you’re a property investor, chances are you’re paying off at least two mortgages (being the home you live in and your investment property), so these conventional methods of raising equity in your investment might not be realistic for you.

Whether you’re just strapped for cash, or you’re trying to focus on paying off the home you’re living in first; here are some specific ways to raise equity in an investment property.

Increase rent

A simple way for you to raise equity in your investment property is by increasing the amount of rent you charge your tenants. Increasing the rental amount means you have extra money to go towards your mortgage, which will in turn raise more equity. While this concept itself is simple, the matter of increasing your rent can sometimes prove more challenging. Each state and territory has different rental increase laws, so you should check what applies to you.

To give you an idea of what you might expect, rent increases in Queensland can only come into effect every six months. For periodic agreements, the tenants must be given two months notice before the new rent amount comes into effect. Rent cannot be increased during a fixed agreement unless the the lease states rent will be increased; the agreement states the new amount; the property manager gives the tenant two months notice in writing; and it’s been at least six months since the tenancy started/the last rental increase. Rent can also be increased with a lease renewal, as long as it has been six months since the last increase. There are a few other rules and regulations, but this is a basic outline of how rental increases work in Queensland.

To show you how these rules differ between states, rent can only be increased every 12 months in NSW. This is why it’s important to check what applies to your property.

Have good tenants

Making sure you have good tenants in your property is extremely important to ensure your property holds its value. If you have tenants that are destructive or that don’t pay their rent, this can be detrimental to you and your valuable asset.

If the property is damaged, you might end up needing to fork out thousands of dollars for repairs (depending on the extent of damage and whether you have landlord insurance). If they pay rent late or don’t it at all, this could impact your ability to cover your mortgage.

Either way, having good tenants is important not only to ensure your property goes up in value, but so that you can cover your mortgage.

Renovate

As we briefly touched on, refinancing and using your equity to renovate can be a great way to increase your property’s value. Your equity goes up with your home’s value (and your decreasing mortgage), so by increasing your home’s value more than the equity you used to complete the renovations, you increase your equity.

Additionally, by increasing your home’s value, you can choose to charge more rent and likely attract a better calibre of tenant (full circle moment). Evidently, renovating could increase your home’s equity in more ways than one.

Savings.com.au’s two cents

Refinancing your investment loan can be a great way to increase your property’s worth, your investment portfolio, or just to get a better deal on your mortgage. In any case, it can be a worthy use of your time to calculate if the benefits outweigh the drawbacks. If you’re not sure whether refinancing is right for you, consider speaking to a financial adviser.

Image by Towfiqu Barbhuiya on Unsplash

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