Interest on an investment property loan is generally tax deductible, but some borrowing costs are not immediately deductible and knowing the difference can count. Structuring your loan correctly is critical.
It is best to avoid mixing up investment property loans with your home loan. Ideally they need to be separate so you can maximise your ongoing taxation benefits and reduce your accounting costs.
Fixed or Variable
It really depends on circumstances but consider both options carefully before you decide.
Over time variable rates have proven to be cheaper, but selecting a fixed rate loan at the right time can really pay off. Rates will tend to rise when an economy is doing well, so increasing interest rates are not always bad news for property investors. This is because one would expect rising property prices when the economy is doing well.
Most investment loans should be set up as interest only as this increases the tax effectiveness of your investment, particularly if you have a home loan.
The reason interest only loans work well for investment properties, is that a principal and Interest loan reduces the negative gearing benefit as you pay down the amount of your loan. Consideration should also be given to an investment loan that gives you the opportunity of paying interest in advance or has an offset account.
Line of Credit (LOC)
When purchasing a home, most people pay a deposit and then take out a loan or a mortgage for the remainder. This means that most people start out with at least a small amount of equity in their home. Ideally the property’s value will increase over time. Combined with regular mortgage payments the equity in the house will increase.
A line of credit equity loan allows a homeowner to receive a line of credit up to the current equity in the house. In most situations, the credit limit is set at 80% of the value of the property. So if you had $300,000 equity in a $500,000 property, the line of credit would likely be $200,000 (LOC = [80% of value] minus debt).
The borrower can access the money at any time, without having to apply for it. Access will be via a special cheque, card or dedicated internet banking accounts. The borrower can take out as much or as little money as they choose, as long as it doesn’t go over the limit.
Once money has been drawn down from the line of credit equity loan interest repayments are required on that amount – not the line of credit limit unused. If a borrower decides to make repayments, it can be added to the line of credit. For example, if a borrower takes $80,000 from their line of credit for a deposit and they pay back $1000 a month, the repayment can be drawn from the line of credit so that the amount drawn down is now $81,000 (as long as the credit limit is not exceeded). However, equity is being depleted in this case.