Smart ways to approach buying an investment unit

Buying an investment unit means taking out a loan that works differently to the one you might use for your own home.

The deposit you need is higher, the interest rate is typically a bit higher too, and lenders assess the property and your income through a different lens. If this is your first time buying an investment property, the jargon alone can feel like a barrier. The section below walks through what changes when you borrow to invest, and how those changes play out when you're looking at a unit in Merrylands.

What deposit do I need for an investment unit?

You'll need at least 10 per cent of the purchase price, though most lenders prefer 20 per cent to avoid Lenders Mortgage Insurance. LMI is a one-off premium that protects the lender if you default, and it can add thousands to your upfront costs. At a 10 per cent deposit, you'll pay LMI. At 20 per cent, you usually won't.

Consider someone looking at a two-bedroom unit in Merrylands. If they have a 15 per cent deposit, they're still below the 20 per cent threshold, so LMI applies. The premium is calculated on a sliding scale based on the loan amount and the loan to value ratio. Some lenders allow you to capitalise the premium into the loan itself, which means you don't pay it upfront, but you do pay interest on it for the life of the loan. That trade-off matters when you're comparing loan structures.

Deposit also includes your genuine savings. Lenders want to see that a portion of your deposit has been in your account for at least three months and wasn't a one-off gift or sale of assets. For investment loans, this requirement is applied more strictly than it would be for an owner-occupier loan.

How lenders assess rental income

Lenders don't count 100 per cent of the rental income when they assess your borrowing capacity. Most will count between 70 and 80 per cent, depending on the lender and the property type. The reduction accounts for vacancy periods, maintenance costs, and the possibility that the property might sit empty between tenants.

In Merrylands, where there's a consistent rental market driven by proximity to Parramatta and the train line, vacancy rates are relatively low. That doesn't change how the lender calculates your income, but it does affect the underlying viability of the investment. A unit close to Merrylands station or near McFarlane Street will typically rent faster than one further from transport, and that feeds into your ability to hold the loan comfortably during any gap in tenancy.

When you apply, the lender will also assess your other income and expenses. If you already own your own home and are carrying a mortgage, both loans are factored in. The same serviceability buffer that applies to owner-occupier loans applies here too, currently 3.0 percentage points above the actual rate. That means if the investment loan rate is 6.5 per cent, the lender tests whether you could still afford repayments at 9.5 per cent.

Interest only or principal and interest repayments?

An interest only loan lets you pay just the interest portion each month, without reducing the principal balance. This keeps your monthly repayments lower, which can be useful if the property is negatively geared and you're relying on rental income to cover most of the cost.

For properties acquired after 12 May last year, losses from established residential investment properties can only be offset against income from other residential properties, including capital gains, from the income year starting 1 July next year. Losses can be carried forward indefinitely. That change makes cash flow more important, because you can't use the loss to reduce tax on your salary in the same year unless the property qualifies as a new build.

If you're buying a unit that was previously owner-occupied or tenanted, it's classified as established. Interest only repayments mean you're not building equity through the loan, but you are keeping more cash available each month. Principal and interest repayments are higher, but they reduce the loan balance over time and can make refinancing or portfolio growth smoother down the track.

Most lenders allow interest only periods of up to five years on investment loans. After that, the loan reverts to principal and interest unless you apply to extend. Some lenders cap the interest only period at a lower LVR if the loan is above 80 per cent.

Variable or fixed rate for an investment loan?

Variable rates move with the market, and they usually come with features like offset accounts and the ability to make extra repayments without penalty. Fixed rates lock in your repayment for a set period, typically one to five years, but they come with restrictions. If you want to pay off the loan early or refinance during the fixed term, break costs can apply.

For investment purposes, an offset account can be particularly valuable. Every dollar sitting in the offset reduces the interest you're charged on the loan, and because you're not paying down the principal, the full loan amount remains deductible. If you fix the rate, you usually lose access to an offset, or it's limited to a partial offset that doesn't deliver the same tax efficiency.

Some buyers split the loan, fixing part and leaving part variable. That gives you rate certainty on a portion while keeping flexibility on the rest. The split doesn't need to be 50-50. You can fix 30 per cent and leave 70 per cent variable, or any other combination that suits your risk tolerance and cash flow.

What lenders look at when the property is a unit

Units come with body corporate fees, and those fees are factored into your serviceability assessment. A two-bedroom unit in a complex off Merrylands Road might have quarterly body corporate fees of $800 to $1,200, depending on the age of the building and the facilities. Lenders add that figure to your other expenses when they calculate how much you can borrow.

They also check the strata report. If the building has a history of special levies, unresolved maintenance issues, or low sinking fund balances, some lenders will reduce the amount they're willing to lend or decline the application altogether. The strata report is part of your conveyancing process, but it's worth getting a copy early if you're serious about a particular property, because it can affect your borrowing capacity before you reach settlement.

Lenders may also cap the number of units they'll lend against in a single complex. If more than a certain percentage of units in the building are already mortgaged with the same lender, or if a large proportion are investor-owned rather than owner-occupied, the lender might treat the property as higher risk. That's more common in high-rise developments than in smaller walk-up blocks, but it's something to ask your broker about before you make an offer.

Borrowing capacity and the debt-to-income limit

From February this year, lenders can only write up to 20 per cent of their new investment loans to borrowers with a total debt-to-income ratio of six times or more. If your total borrowing, including the new investment loan, exceeds six times your gross annual income, you might fall into that 20 per cent cap. Whether the lender approves your application depends on how much of their quarterly allocation they've already used.

In practice, most investors with a DTI above six are either buying a second or third property, or they're self-employed with variable income. The cap doesn't prevent you from borrowing, but it does mean some lenders will decline an application that they might have approved previously, even if your income can service the loan. If you're close to the threshold, your broker can help you compare lenders who still have capacity under the cap or who apply it more flexibly.

Refinancing an investment loan later

Refinancing can make sense if rates have dropped, if you want to access equity for another purchase, or if your current loan no longer suits your situation. Investment loan refinancing follows the same serviceability rules as a new application, so even if you've been paying the loan without issue for several years, the new lender will reassess your income, expenses, and the property value.

If the property has increased in value, you might be able to refinance at a lower LVR and negotiate a better rate. If the value has stayed flat or declined, refinancing becomes harder, particularly if you're still above 80 per cent LVR. Lenders will also want an updated rental appraisal, and they'll reassess your other debts and income at the time you apply.

Most lenders allow one free refinance per year on a variable loan without charging break costs. If you're on a fixed rate, the break cost is calculated based on how much the lender loses by letting you out of the contract early. The calculation depends on the difference between your fixed rate and the current wholesale rate, and on how much time is left in the fixed term. Your broker can request a break cost estimate before you commit to refinancing, so you know whether the saving outweighs the cost.

Tax deductions and claimable expenses

Interest on an investment loan is fully deductible, as are body corporate fees, property management fees, council rates, insurance, repairs, and depreciation. You can't claim the cost of improvements that add value to the property, like renovating a kitchen or adding a second bathroom, but you can claim the depreciation on those improvements over time.

Negative gearing used to allow you to offset the loss from your investment property against your salary or other income in the same year. For established properties purchased after 12 May last year, that's no longer the case from the income year starting 1 July next year. Losses can only be offset against other residential property income, including capital gains when you sell. You can carry forward the loss indefinitely, which means it's not wasted, but the timing of the tax benefit shifts.

If you're buying a unit that qualifies as a new build, the old negative gearing rules still apply. A new build is a dwelling constructed on previously vacant land, or a development where the number of dwellings increased compared to what was there before. A knock-down rebuild that results in the same number of dwellings doesn't qualify, and neither does a renovation. If you're not sure whether a property qualifies, check with your broker or accountant before you settle, because the distinction affects both your tax position and your borrowing strategy.

If you're weighing up investment loan options or want to understand how the numbers work for a specific unit in Merrylands, call one of our team or book an appointment at a time that works for you. We'll walk through your deposit, your borrowing capacity, and the loan structure that makes sense for where you're at and where you're heading.

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