Investment Property Loan Structure, Home Purchase, Building Construction, Advice

Best Loan Structure for Investment Property

Homebuying Property Advice Article

22 Feb 2019

Best Loan Structure for investment property tips

Best Loan Structure for Investment Property Guide

If you’re thinking about buying a property and turning it into a short-term or long-term profit, you’re probably facing a difficult time of deciding which loan structure to implement. There are many ways of approaching this, and finding a suitable solution might be a burdensome process if you’re not paying close attention to all the nuances.

But there is a good reason why you have so many miscellaneous options to choose from. There’s not only one correct answer or method, even if you crunch all the numbers and go into the specifics of your personal situation. But depending on your position, there are still some of the most common ways on how to decide which option is best for you.

So let’s look at the pros and cons of different loan structures in more detail.

Principal and Interest Loans

One of the most frequent and widespread ways of structuring your loan is to opt out for principal and interest loan (P+I). We are introducing this scenario in the first place because the combination of the two can be beneficial in more than one way.

For example, while you’re paying off your interest, you also take care of the principal amount which the lender has borrowed to you. That way you can completely pay off your asset. Also, the lenders tend to decrease the interest rates when you choose this option, because they also get a hold of the equity faster.

The disadvantage of this particular loan would be the fact that the amounts that you can redraw are smaller as the loan increases. At the same time, the repayments are usually somewhat higher than some of the other structures in which you could potentially secure the steadier cash-flow more quickly.

Interest-only Loans

An interest-only type of loan (IO) is the one in which you pay the lender only the interest, without reducing the principal amount simultaneously. Who would benefit the most from this loan structure? Remember what we said earlier about the disadvantage of P+I in securing the steady cash-flow faster.

This is exactly where the pros of IO kick in: when you don’t have to allot a certain amount of money for paying off the principal right away, you are increasing your cash-flow. But, there are also some disadvantages to this method also, as you could imagine. Interest rates are higher than with P+I, IO terms are not applicable throughout the full loan term, the criteria for lending are more rigorous, to name a few.

Personal Loans

With all this being said, you might want to consider personal loans, and those can be secured or unsecured. With Personal Loans, you are not even obliged to purchase a property, like with some of the others. You can use the money for whatever purpose you need and want.

This gives you more flexibility, as you can allocate the money however you feel like. These are strictly cash loans, but as we’ve mentioned, there are essentially two ways that you can get them. The first would have to include pledging an asset that you already possess, e.g. piece of property that you already own, like a house, a piece of land, or maybe some pricy vehicle like a car or a boat, etc. This is what is called a secured personal loan.

The advantage of this is that the interest rates are lower because the lender is secured on his/her part with an asset that you are pledging in advance. At the same time, you don’t have some of the advantages as you would have with unsecured personal loans online, for example. This type of loan is more suitable for people who are just starting with something but don’t have any assets to pledge as security to the lender.

The interest rates are typically higher with unsecured personal loans like you would expect them to be, because the borrower is not offering the lender any type of safety in return. That doesn’t mean the lender is completely unprotected here.

If the payments are late or completely ignored, the lender issues a court order in most cases, and then seizes any of the assets the borrower might have, but did not pledge, or takes away the part of his/her salary, et cetera.

Fixed Loan

As far as taking a fixed loan goes, you don’t have to guess twice what it’s all about. This type of loan offers you rates that are ’carved in stone’. Once you sign up for this deal, you know exactly what lies ahead of you, in terms of paying off your lender. It’s all smooth sailing from down there, you just have to ensure that you are right on time with your payments.

There are no surprises with this scenario, as interest rates are never fluctuating depending on the market. Now, you might be thinking: ’Who wouldn’t want that type of security and why would I trade it for a deal which could potentially cost me more than I have agreed upon in the first place?’

But, on the other hand, you should also ask yourself these questions: ’Are there limits to extra repayments?’, ’Are some of the traits such as a redraw and offset at my disposal?’, ’What if interest rates fall, will I somehow be affected?’. As answers to these questions are ’yes’, ’no’, and ’no’, in that particular order, you start to get a sense of what is it that you’re possibly losing with this option.

Variable Loan

The variable loan is the other side of the fixed loan coin, as the name pinpointly suggests. All the disadvantages of the fixed loan are fixed with the variable loan and vice versa. The variable loan has an upper hand over the fixed loan in a way that making extra repayments is made easier, traits such as redraw and offset are available with this option, loan flexibility is greater, and so on.

But because interest rates are not fixed, your repayments are not steady and are oscillating, depending on the market. If you do the math and sense that perhaps the market is changing in your favor, those cons are quickly turned into pros, as you are repaying your debt at lower rates than those that were valid when you borrowed the money.

To conclude: although you can’t get a definite answer to the question which loan structure is best for investment property in general, you can make a valid case for any of these mentioned loan structures, depending on the particular type of situation that you find yourself in. There are many viable options out there, and sometimes choosing the best one can be a mixture of both craft and sheer luck.

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