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Why are investment property mortgage rates higher?

  • June 10 2020
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Invest

Why are investment property mortgage rates higher?

By Zarah Mae Torrazo
June 10 2020

Lenders tend to charge more for mortgages on investment properties. Here are the reasons why and some tips on how you can get a lower rate.

investment property mortgage rates

Why are investment property mortgage rates higher?

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  • June 10 2020
  • Share

Lenders tend to charge more for mortgages on investment properties. Here are the reasons why and some tips on how you can get a lower rate.

investment property mortgage rates

Property is one of the most popular investment options among Australian investors. And it’s easy to see why. If you purchase an investment property at the right price and finance it correctly, it can provide you with cash flow almost immediately as a rental or a commercial space. 

But scoring a low mortgage rate on an income-generating property is more difficult than for a residential property. This is because lenders tend to charge more for “non-owner-occupied” mortgages or properties that you don’t plan to live in. 

You may be wondering why this is the case. Let us take a closer look at the reasons why mortgage rates on investment properties are higher and how you can get a lower rate on your loan.

Why do lenders charge investors higher rates for investment properties?

Generally, investment/rental property mortgage rates are higher than for owner-occupied home loans. This is because investors are viewed as riskier borrowers compared with those who are buying a home to live in.

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Here’s a little more detail on why lenders charge a higher interest rate on investment property mortgages:

Your income depends on your investment property. 

One of the biggest reasons for the higher rates is because lenders view your investment property as your income source. Most investors purchase an investment property to generate rental income, which can depend on several factors that sometimes cannot guarantee investment returns. Another way most people make money from property investments is by “flipping” it (purchasing a house and reselling it when property prices are higher at a later time). 

Due to the unpredictable nature of your investment’s profitability, lenders are uncertain of your ability to pay for your mortgage. There are no guarantees when investing; if you can’t secure tenants for your property, or if it doesn’t increase in value, you could find yourself in financial trouble. If you find yourself in any of these worst-case scenarios, you may not have the financial means to repay your loan, presenting a risk to the lender. Having higher charges for your loan helps to safeguard against this risk and soften the blow if things go south in the property market. 

An investment property loan can be a flight risk. 

If you are occupying a property with an attached mortgage, there is a lower chance that you will abandon ship when things go awry. The most practical (and usually taken) path to get through a bad recession or personal financial crisis is to ensure that you make those mortgage payments on time to avoid losing a roof over your head. 

However, it’s a different case for an investment property mortgage. When you buy a property for income-generating purposes, you have a lesser personal stake. Ideally, you want to get some rental yield from your property, but losing it will not mean risking you (or your family’s) security. Because of this, lenders think that there is a higher chance you will take off and abandon a home (and its loan) when your financial situation hits rock bottom or if an investment property may not turn out to be profitable. 

Because of this flight risk, lenders are more cautious before approving a home loan for property investors. This also leads to a higher interest rate and stricter requirements for approval. 

Unstable job (for full-time investors) 

Home buyers that are classified to have non-traditional jobs (e.g. freelancers) are usually required to utilise a non-qualified mortgage (non-QM) or a home loan that doesn’t comply with the Consumer Financial Protection Bureau’s existing rules on qualified mortgages (QM). This gives people who are not able to prove they are able to make the mortgage payments a chance to apply for a home loan. Non-QMs are usually used in this situation due to the unpredictability of a person’s employment and overall income.  

This perception also applies to full-time investors. If a big part of your income depends on your rental or investment properties, there is no guarantee for lenders that you will have a steady income. 

To protect themselves from these risks, non-QMs are usually hit with higher interest rates compared with other financing options, and the cost can significantly build up in the long term. 

Your assets are locked up.

If your money is all tied up to a real estate property, it means there are fewer ways for you to repay a loan if your financial situation worsens. This in turn presents an additional risk to the lender and will prompt a higher interest rate. To get a decent interest rate on your investment property loan, you need to have a solid cash reserve and liquid assets. 

How can I get a lower interest rate on my investment property mortgage?

Investors are seen as riskier borrowers because buying a property as an investment is different to buying an owner-occupied home, leading to higher interest rates. But don’t fret about getting stuck with a high interest rate on your mortgage, here are some ways to get a better deal on your home loan. 

Choose an interest rate that will be suitable for you.

Investment property buyers have an option between a fixed or variable interest rate. A fixed interest rate allows you to have a set repayment amount for a locked-in period of time, which spans between one to five years. On the other hand, a variable interest rate can be changed by the lender, meaning your mortgage repayments could increase or decrease depending on the current state of the economy. 

The best interest rate option will depend on your financial situation and your personal preferences. While a fixed rate will help you better budget your repayments due to its stable amount, this will also mean that you can miss out on savings if the lender lowers its rates. 

Meanwhile, a variable rate mortgage will save you money if rates decline. But this is a double-edged sword. It could also mean repayments could increase if rates rise. One advantage of variable rate loans is that it offers more flexible mortgage features, which could help you better manage your repayments and save money on interest costs.

Make a big down payment when you buy an investment property.

Generally, you will need to pay 20 per cent down payment to secure a mortgage from a lender. However, if you put in a higher deposit upon buying an investment property, you may qualify for an even better interest rate and more flexible payment terms. 

A bigger down payment gives you more “stake in the result” and means you are bound to lose more if the investment does not pan out. This can result in big incentives. It can also give banks bigger protection against losing money. If the investment fails to generate profit, you will lose your whole stake before the bank begins to bleed any money in the property. 

Maintain a good credit score.

You’ll have a better chance at qualifying for an investment property loan (and better interest rates) if you have a good credit rating. Also, if you are looking for other methods to finance your mortgage, it will be extremely advantageous for you to make a good impression with your potential lenders. To learn more about improving your credit score, read here. 

Ask advise from a mortgage broker.

Like all investment decisions, it is vital to do your research. A mortgage broker can be a good source of information when making your decision on purchasing an investment property. An experienced broker will know which lenders or banks are currently offering the best rates, which are more flexible with their policies and which will best fit your situation. In some instances, they have access to loan types or rates that are not offered to the general public, which can mean more savings for you.  

Don’t be complacent.

While it seems convenient to settle for a rate and loan situation you got, don’t be lazy. Keep tracking mortgage promotions that are being offered by lenders and make note to revisit your financial plans involving your loan annually. Remember that a lot of things can change during the repayment course of your loan, particularly your personal financial situation – you may get a big pay increase or you may have a big investment that paid off during the mortgage term, these can impact your negotiation powers and help you improve your interest rate and loan features. 

Conclusion 

Despite the higher mortgage rates, investment property is generally a good long-term investment. Make sure you are able to afford payments when you take out a loan on your investment property. Also, don’t be afraid to explore other opportunities to further improve your interest rate and loan features. 

Why are investment property mortgage rates higher?
investment property mortgage rates
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