The funds provided by an investment loan are used to purchase or develop assets that will produce income and/or capital growth. Ideally, they produce both. For example, an investment property loan where you purchase a home, unit or townhouse to rent out to tenants will generate income for you. It will also potentially generate capital growth for you as the value of the property hopefully increases over time. Australian property prices have historically shown an upward trend over the long term.

If an investment is generating income, you must include that income in your annual tax return. The income is taxable. But it’s not all bad news on the tax front. Because the investment is generating taxable income, you can write off associated legitimate expenses as tax deductions to reduce your taxable income. Using the investment property example, associated expenses that you could deduct from your rental income include:

• your loan interest
• rates and water charges
• land tax
• gardening and maintenance
• cleaning
• insurance
• real estate agent fees
• costs of advertising for tenants
• cost of repairs
• pest control fees
• body corporate fees (if applicable)
• some legal expenses
• borrowing expenses such as loan establishment and ongoing fees
• depreciation on furniture and appliances (i.e. the decline in their value over time due to wear and tear)
• capital works expenditure

It’s important to bear in mind that investment loans are generally perceived as higher risk by lenders, and they charge higher interest rates accordingly. An offset account is separate to your investment loan, but the interest it earns can be used to reduce your investment loan interest.

The offset account could be a cheque or savings account that you use every day. Instead of the interest on your funds in the cheque or savings account being credited to that account, the balance of your offset account can be applied to your investment property mortgage.

Negative gearing is the term used to describe the situation where a person borrows money for an investment asset, and the income the asset produces is less than the combined interest cost and associated expenses of maintaining the asset. Let’s look at the pros and cons of negative gearing using an example.

Imagine you earn a taxable income of $100,000 a year from your job’s salary and that you also have an investment property worth $500,000 that generates $26,000 per year for you in rental income. Let’s also assume that you have an investment property loan of $450,000 on the property and that your interest and associated expenses on it are $30,000 in the same year. That means your investment property expenses exceed your investment property income by $4000. So, instead of having to add $26,000 onto your $100,000 taxable income, you deduct $4000 to end up with a taxable income of $96,000

The tax savings would be as follows:
Tax on $100,000 using 2017/2018 marginal rates: $26,632
Tax on $96,000 using 2017/2018 marginal rates: $25,072
Total tax saving: $1,560
And the higher your taxable income, the more tax you would save.

Pros:

• You lower your tax obligation.
• You can use the rent that your property generates to make full or partial repayments on your investment property loan.
• Because the rental income the investment property is likely to generate can be used to make your investment property loan repayments, your borrowing capacity will increase (compared to just relying on your salary for the repayments). If you can use that increased borrowing capacity to buy a better investment property (e.g. in a more desirable area where you’ll be able to charge more rent), both your income and capital growth prospects will be higher.

Cons:

• Although you lower your tax obligation, you are still out of pocket overall using a negative gearing strategy (i.e. your investment expenses are greater than your investment income). To be in a better overall financial position, you therefore need to rely on your investment property growing in value over time to more than offset your income loss.
• It’s current Labor party policy to reform existing negative gearing provisions if they win the next federal election. Their policy is to limit negative gearing to new houses only, though the planned changes won’t be retrospective. At the moment, investors can negatively gear both new and established properties. There is a risk therefore that negative gearing provisions will change if Labor wins government and the next federal election is due before mid-2019. If you want to take advantage of negative gearing for an existing property, it would be best to buy one with an investment property loan before then.
• You may not always be able to find tenants for your investment property. You need to factor in potential vacancy periods into your financial calculations. You won’t earn rent when your investment property is vacant, and when it is and it’s a highly competitive market, you may need to reduce your rent to attract tenants.
• Capital growth on an investment property is typically only achieved over the long term. If you’re looking for a quick return on investment, an investment property loan that is negatively geared is not the best investment for you.

Positive gearing is the opposite of negative gearing. When you’re positively geared, your investment income exceeds your investment expenses. Let’s look at an example again.

Again, imagine that you have a taxable income of $100,000 a year from your job’s salary and that you have an investment property worth $500,000 that generates $26,000 per year in rental income. Let’s also assume again that you have an investment property loan of $450,000 on the property. But now, let’s also assume that your interest and associated expenses for the property are only $22,000 in the same year.  Your investment income exceeds your income by $4,000. That figure will need to be added to your taxable income. Let’s see how that affects your tax obligation.

Tax on $100,000 using 2017/2018 marginal rates: $26,632
Tax on $104,000 using 2017/2018 marginal rates: $28,192
Additional tax payable: $1,560

Pros:

• You aren’t out of pocket with positive gearing like you are with negative gearing (i.e. your investment income exceeds your investment expenses). You therefore don’t necessarily need your investment to have capital growth to be in a financially better position, but of course it would be nice and that’s what you should be aiming for as well!
• Positive gearing strategies won’t be affected by current Labor policy if they win the next federal election. This should be a strategy you can use even if they win government and you purchase an existing investment property after they do.
• As with negative gearing, you’ll still have a lower tax obligation than if you didn’t have any investment expenses to deduct.
• As with negative gearing, the rent the property generates can be used to make full or partial investment loan repayments.
• Again, as with negative gearing, the rent the property generates will increase your borrowing capacity. In fact, you’ll likely be able to borrow even more than you would with a negatively geared investment strategy.

Cons:

• You’ll have a higher tax obligation with positive gearing than you would have with negative gearing.
• As with negative gearing, you may not always be able to find tenants for your investment property, so again you need to factor this into your income projections. There may be times when you can’t find tenants for your investment property and you may have to drop the rent you charge to fill the vacancy.
• Again, as with negative gearing, capital growth on an investment property is typically only achieved over the long term. If you’re looking for a quick return on investment, an investment property loan may not be best for you, even if it is positively geared.

As the name implies, capital gains tax (CGT) is a tax you pay on a capital gain. The gain is the difference between what you paid for the asset and the proceeds you received from its sale. Although it’s a tax, it’s preferable to have to pay it because at least it means you have had capital growth on your investment. It’s only payable when an investment asset is sold, and the gain is included as part of your income in that year.

As mentioned earlier, investment loans are perceived as higher risk by lenders so their lending criteria is stricter. For example, on an investment property loan they’ll likely be conservative in their assessment of how much rental income it will generate, especially if an applicant is relying heavily on that income to meet their loan repayments. As with any loan, your chances of approval for an investment property loan will be high if you have a good credit history and stable, full-time employment. Your chances will also increase if you have:

• Genuine savings of at least 5% of the value of the investment property. Genuine savings are those you can prove you have generated yourself over time (e.g. they aren’t a lump sum gift or an inheritance). Genuine savings demonstrate to a lender that you are able to save and budget, decreasing your potential credit risk. If these savings aren’t used for your deposit, they can also act as a safety buffer to meet your loan repayments if your investment property becomes vacant and is not earning you any rental income.
• A significant deposit to reduce your loan-to-value ratio (LVR). An LVR is the amount you want to borrow expressed as a percentage of the value of the investment property you want to buy. Most lenders will want this ratio to be below 90%. For higher LVR amounts, they will also usually require you to take out mortgage insurance in case you’re unable to meet your loan repayments, so this is an additional expense you need to factor in. But of course, unlike mortgage insurance for an owner-occupied home loan, mortgage insurance on an investment property is a legitimate tax-deductible expense.

Most Australian lenders (both banks and non-banks) offer investment loans. Some do more of this type of lending than others. Their lending policies also differ in terms of the maximum LVRs they’re prepared to accept.

Being a multicultural nation, many Australians have connections with other countries. Some want to buy properties in their former homelands. Other investors may want to buy international properties to take advantage of capital growth trends that can occur from time to time in various international markets.

In general, Australian lenders won’t take an international property as security for an investment loan. But many will be able to help if you meet their normal lending criteria and if you have enough equity in an Australian property to use as security for the international investment property loan.

It’s best to deal with an Australian financial institution that has a branch in the country where you want to buy your property. Before you take the plunge of buying internationally, you should also consider general international economic conditions as well as the recent economic performance of the country where you want to buy. For example, the values of properties in many international markets were affected by the Global Financial Crisis and its aftermath. Some countries will also have restrictions on foreign investment or other controls and legal issues that you’ll need to be aware of.

If you do go ahead and purchase an international investment property, it will impact on your Australian income tax obligations, but you can use gearing strategies to legally minimise those. You’ll also be liable for CGT upon the sale of the property if you do make a capital gain.

In summary, an investment property loan can be a very effective way to generate both income and capital growth to improve your financial position over time. But there are many factors to consider. As a mortgage broker, we’re highly experienced with investment property loans. We can take the time to understand your needs and circumstances so we can:

• Advise you on everything you need to know, including which lenders are more likely to approve your investment property loan application
• Help you prepare your application
• Negotiate the best possible deal for you
• Help you understand loan documentation, terms and conditions.