Case Study / Refinance / Investment
When you move out of your home and rent it out, the loan needs to change too. I refinanced a $1,537,000 owner occupied, principal and interest loan into a $1,540,000 interest only investment loan with a major bank, over a new 30 year term. Interest only repayments improved their cashflow, which is what their financial planner set out to do.
The clients are a couple who had moved out of their home and were renting it out. Their loan was still set up the way it was on the day they bought. It was an owner occupied, principal and interest loan of $1,537,000 on a home they no longer lived in.
Their financial planner's plan was to improve their cashflow by moving the loan to interest only repayments. My job was to set the loan up to fit that plan.
Interest rates depend on the type of loan and what it's for. Owner occupied loans are priced differently from investment loans. Principal and interest loans are priced differently from interest only. Their loan was owner occupied and principal and interest. They no longer lived in the property and it was being rented out, which made it an investment property. So the loan had to be refinanced as an investment loan.
The repayment type had to change as well. Principal and interest repayments reduce the loan every month, which suits a home you live in. Interest only repayments cover just the interest, so the repayment is lower and the difference is freed up each month. That was the point of the plan.
I refinanced the loan to a major bank as a $1,540,000 investment loan with interest only repayments, over a new 30 year term.
The interest only repayments are what lowered their repayments straight away. The 30 year term matters later. An interest only period doesn't last forever. When it ends, the loan reverts to principal and interest over whatever is left of the term. Starting a new 30 year term means the principal is repaid over more years than if the loan had stayed on what remained of the old one.
The bank assesses an interest only loan on the principal and interest repayment that follows, so the application had to stand up on that basis. One borrower is employed on a strong income. The other is self-employed, and the bank's policy let us use the most recent tax return on its own, which was the higher year. The property also has a granny flat, and rent from both the main house and the granny flat was counted. At 67% LVR, there was no lenders mortgage insurance to pay.
A $1,540,000 investment loan with a major bank, replacing the $1,537,000 owner occupied loan. Interest only repayments lowered what they pay each month, which is what the financial plan set out to do. The interest only period runs for five years. When it ends, the loan reverts to principal and interest over the remaining 25 years of the term. The loan now matches how they use the property, and it does the job their planner needed it to do.
Interest only isn't automatically the right choice. You aren't paying the loan down, so the full balance is still owing when the interest only period ends. Interest only rates are also usually higher than principal and interest rates. It suits when there's a clear reason for it, and improving cashflow as part of a financial plan is a good one.
It's worth knowing what happens at the end too. Lenders commonly offer interest only on investment loans for up to five years at a time. After that the loan reverts to principal and interest, and the repayment rises because the principal is now being repaid. You can apply to extend the interest only period at that point, but the lender will assess the loan again.
Usually, yes. Interest rates depend on the loan type and purpose, so owner occupied and investment loans are priced differently. Once you no longer live in the property and it's rented out, it's an investment property and the loan should reflect that. You can change it with your current lender or refinance to a new one, which is often a good time to look at the repayment type and loan term as well.
Most lenders offer interest only on investment loans, commonly for up to five years at a time, after which the loan reverts to principal and interest. The bank checks that you can afford the principal and interest repayments that follow, so both your income and the rental income count. Whether interest only suits you depends on what you plan to do with the cashflow it frees up.
On a principal and interest loan, a new 30 year term lowers the repayment because the loan is spread over more years. On an interest only loan, the term doesn't change the repayment during the interest only period. It matters afterwards, because the principal is then repaid over whatever is left of the term. The longer that is, the lower the repayment. The trade off is more interest over the life of the loan.
This case study describes a real loan Shane arranged, anonymised. Every situation is different and past results are not a guarantee of what a lender will approve for you. The information on this page is general in nature and does not take your objectives, financial situation or needs into account.
Your loan requirements will most likely change over the time you own a property. Get in touch with Shane to talk about aligning your loan with your new plans. More on investment loans.
Shane specialises in helping clients across Coogee, Clovelly, Bronte, Bondi, and all surrounding Eastern Suburbs.