Interest Rates and Investment Properties: A Guide
In this guide, we go through a few frequently asked questions in regard to investment properties and interest rates: why they’re higher for investment properties, interest rates on owner-occupied vs investment loans, investment loans vs principal and interest loans, and more.
Join us as we unravel the complexities of interest rates, and if you have any questions, don’t hesitate to contact us. Our team of commercial buyers agents is always ready to provide guidance and support to help you successfully build your portfolio, all across SE Queensland.
Why Are Interest Rates Higher On Investment Property?
Interest rates are generally higher on investment properties for a few key reasons, which primarily revolve around the perceived risk associated with these types of loans.
- Higher risk
Lenders perceive investment properties as a higher risk compared to owner-occupied homes. This is because, in times of financial difficulty, borrowers are generally more likely to keep up payments on their own home rather than an investment property.
- More likely to default
Investors are more likely to default on investment loans than on their primary residence loans, again leading lenders to view investment loans as riskier. In the event of a market downturn, an investor might find it challenging to service the loan or sell the property.
- Variable income streams
The income streams for investment loans are generally more variable. Think of rental income for example – this can fluctuate over time with tenants moving in and out, introducing another element of risk.
To compensate for this increased risk, lenders charge higher interest rates on investment property loans. While this might sound daunting, a well-planned and well-researched investment strategy can yield fantastic returns, even with higher interest rates.
Owner-occupied vs Investment Loans
As previously outlined, interest rates for investment properties in Australia can be notably higher than those for primary residences. The difference is typically around 0.5% to 1.0%, but it can vary depending on a variety of factors, such as the lender’s policies, the loan-to-value ratio, the borrower’s credit score, and the type of property.
This higher rate translates into increased borrowing costs over the life of the loan. For example, if you take a $500,000 loan and pay it back over 30 years at 5% interest, your final total interest paid is $466,279. If that were to increase to 6% over the 30 year period, the total interest paid would be $579,191 – over a $100,000 increase!
That being said, there are numerous ways to mitigate these costs, such as negotiating with lenders for better rates, making extra repayments where possible, and carefully planning your investment strategy to maximise rental income.
Investment-only Loans vs Principal Loans
Another important consideration when comparing interest rates is the type of investment loan. In Australia, lenders generally offer two types of loans for investment properties: interest-only loans and principal and interest loans.
In interest-only loans, the borrower is required to pay only the interest on the loan for a set period, typically 5 to 10 years. This can significantly lower the borrower’s monthly payments during the interest-only period, but it also means that the principal loan amount doesn’t decrease during this time. Once the interest-only period ends, the loan switches to a principal and interest loan, and the monthly payments increase.
On the other hand, principal and interest loans require the borrower to repay the principal and the interest from the start. Monthly payments are higher compared to an interest-only loan, but the principal loan amount decreases over time, reducing the interest costs.
While interest-only loans can be attractive due to lower initial payments, they typically have higher overall interest rates compared to principal and interest loans. This is because lenders perceive interest-only loans as riskier since the principal doesn’t decrease during the interest-only period.
Rising interest rates can significantly affect both types of investment loans. For interest-only loans, higher rates can lead to substantially larger payments during the interest-only period. This could potentially stretch a borrower’s financial capacity, particularly if their investment property’s rental income doesn’t increase correspondingly. On the other hand, for principal and interest loans, rising rates might increase the overall cost of the loan over time. However, as the principal is gradually paid down, the impact of the rate increase may be somewhat mitigated. In both cases, the suitability of a loan type amid rising interest rates will depend on the investor’s individual financial situation and risk tolerance.
Does an Increase in Interest Rates Decrease Property Value?
In an environment where interest rates are rising, the cost of borrowing becomes more expensive, which can influence property value in several ways.
The increased cost of loans reduces the borrowing capacity of potential home buyers, thereby curtailing their purchasing power. This can subsequently lead to a decrease in demand for properties, which in turn could stagnate or slow the growth in property prices.
However, it’s important to note that stagnation in property price growth doesn’t necessarily equate to a fall in property values. Rather, it suggests a period where property prices remain relatively stable without any significant increases – a kind of plateau in the market.
In response to rising interest rates, potential buyers may exhibit increased caution, possibly choosing to delay their property purchases to see how the market evolves. This wait-and-see approach can further reduce the demand for properties and contribute to the slowing of price growth.
On the flip side, a slowdown in price growth, influenced by rising interest rates, could present a silver lining for certain buyers. Those seeking more affordable property options may see this period as an opportune moment to enter the market. In other words, while rising interest rates can present challenges, they can also create potential opportunities within the Queensland housing market.
Get the Best Interest Rates for Your Investment Property with Revolve Commercial
Ready to take the next step in your property investment journey? Don’t hesitate to contact us. Our team of experts is ready to guide you towards a profitable future in the commercial property market. So why wait? Let’s work together to build your portfolio and maximise your investment potential.
Remember, knowledge is power. With Revolve Commercial by your side, you can stay ahead of the curve in the world of commercial property investments.
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