At first glance, financing the purchase of an investment property or another asset may seem simple. You take out a loan, make the transaction, and then pay off the loan balance. However, there are other things to consider – interest rates, taxes and charges, for example. Alternatively, you may not need a loan at all if you have enough equity built up elsewhere. While there is no definitive ‘best’ way to finance an investment, you can reach a positive conclusion by learning more about your financing options.
Debt finance and equity finance
When you source capital to invest in property or another asset, you have two general financing options. These are debt finance and equity finance.
- With debt finance, you are essentially borrowing money from a third party – creating debt that must be repaid.
- With equity finance, you are leveraging money from assets you already own, usually a business or a property. If this money is sufficient, you won’t need to go into debt.
In many cases, however, you might not be able to draw upon enough equity finance to complete the investment transaction simply because there is not enough equity in your home or another asset to cover the total cost. This is why most people will need to take on some debt when they buy an investment property.
Investment loan options
If you do need to take out a loan, you’ll need to decide on the loan type.
Personal loans
You may be able to use a personal loan to finance your investment. With a personal loan, the money is yours to do with as you see fit, and as a result, you are well within your rights to use this to finance an investment. However, there are a few things you’ll need to bear in mind as you consider these options.
- Personal loans tend to be shorter term than home loans and mortgages, which means you’ll need to pay the money back sooner than you would on a home loan. This may be advantageous in terms of interest rates and the total loan cost, but repayments are likely to be high.
- Personal loans are unsecured. Even if you use the loan to buy a property or another asset, the lender won’t have the right to repossess this asset in the event of a default. As a result, you won’t be able to borrow as much as you would with a secured loan.
- Personal loans are not designed for high-value investment asset purchases, and you will need to manage your finances carefully to ensure the loan covers all of the costs beyond the purchase price – such as stamp duty and other fees.
Home loans
If you want to invest in a property, a home loan or mortgage is a better option in most cases. These lending facilities are specially designed with this purpose in mind, and so the loan term, the loan-to-value ratio (LVR) and the repayments will be geared towards supporting your investment purchase.
- Mortgages and home loans are secured, so you can gain a higher LVR when you take out this kind of credit, although the investment purchase is at risk.
- You will be able to find fixed and pre-approved rate loans that protect you from rising rates. As you will need to pay off both the principal and interest of the loan, this is something to consider.
- If approved, the loan will be tied to the investment asset you plan to purchase and cannot be used for any other purpose. Commercial and rental properties may also carry specific conditions and may restrict the LVR the provider is willing to offer.
SMSF loans
Purchasing a property as part of a self-managed super fund (SMSF) can be a good investment. While the SMSF will not be able to hold a mortgage itself, setting up a bare trust or a limited recourse borrowing arrangement (LRBA) in the name of one or more of the trustees can help to grow the value of the fund.
- There will be restrictions on the investment asset purchase. If the asset is a residential property, trustees may not be permitted to live in it.
- There may be tax benefits to an SMSF asset purchase, as a concessionary tax rate is applied to super fund returns.
- You may need to keep a set amount of liquid cash in the SMSF to guarantee enough cash flow to support the ongoing repayments.
Finding the right financing option for you
It can be tricky to find the right financing option for your investment asset purchase, which is why the services of a mortgage broker are so valuable. Reach out to Sydney Brokers to begin your search or to learn more about potential tax deductions and benefits when buying an investment property.
Disclaimer: The content of this article is general in nature and is presented for informative purposes. It is not intended to constitute tax or financial advice, whether general or personal nor is it intended to imply any recommendation or opinion about a financial product. It does not take into consideration your personal situation and may not be relevant to circumstances. Before taking any action, consider your own particular circumstances and seek professional advice. This content is protected by copyright laws and various other intellectual property laws. It is not to be modified, reproduced or republished without prior written consent.