Refinancing your investment property loan is a major financial decision. There could be many reasons to consider refinancing your existing investment, such as switching to a low interest rate or buying an investment. But while the benefits of refinancing are often discussed, many property investors don’t realise what the refinancing costs are and the work involved. This guide provides an overview of refinancing an investment property, the tax deductibility of refinancing costs, and other considerations.
Can you refinance an investment property loan?
Yes, you can refinance an investment property loan, whether your goal is to continue investing in property, consolidate debt or lower monthly repayments. However, there are some things to consider before taking the next step. Refinancing an investment property isn’t free and it can also involve jumping through several hoops.
For instance, most lenders require you to have a minimum amount of equity, typically at least 20%. If you don't have enough equity, you may need to pay lenders mortgage insurance (LMI) when refinancing. It could be a good idea to use an LMI calculator to see how much you might have to pay. Additionally, if you're on a fixed rate, your lender will most likely charge a break cost as you’re exiting the home loan before the fixed period ends.
If you want to lower your monthly repayments, refinancing your investment might make sense for you only if you’re switching to a significantly lower interest rate or if potential savings outweigh refinancing costs. A repayment calculator may be useful here. Before deciding whether to refinance, make sure to compare home loans across different lenders and repayment types, as well as comparison rates to understand your options.
How soon can I refinance my investment property?
The good news is you can generally refinance your investment property loan as soon as you like. But just because you can refinance your home or investment, it doesn't always mean you should.
Aside from being charged potential LMI and break costs, there are a few other things to consider before you decide that it’s a good time to refinance.
- Serviceability — Remember that you’re essentially trying to replace your existing loan with a new loan. Your new lender will want to see that you have a steady income and a good history of paying on time, before agreeing to refinance your investment property. They'll also want to make sure your loan amount is not more than your investment property’s value.
- Changes in circumstances — If your personal or financial situation has changed over time, your refinancing application may not be as straightforward as you might think. For example, if one spouse is having a career break or if you’re approaching retirement, these life changes could also affect your new lender’s perception of whether or not you can afford to pay off the new loan, as well as your borrowing power.
- Refinancing costs — Some may expect to save thousands in home loan repayments by refinancing, but the reality is it can be a costly process. To add to this, the costs are mostly charged upfront, which should be factored into your budget. It’s best to check with your new and existing lender to understand your exact cost of refinancing.
- Interest rates — Interest rates are typically higher for property investors and there’s no guarantee that you can secure a lower rate. If you want to refinance to a lower interest rate, it makes sense to calculate how much you’re actually saving when compared to your existing interest rate. It’s also possible to lose handy features, such as offset accounts, when switching to a lower rate.
- Turnaround time — Lenders are known to prioritise new home loan applications over refinances, so expect to wait anywhere between 1-3 months. Depending on what you intend to use your unlocked equity on, this delay can hold back your plans.
- Tax implications — This applies more to property investors exploring refinancing as an option to draw equity. If you’re planning to spend any unlocked equity for personal reasons, there may be tax implications (more on this below).
How much equity do you need to refinance an investment property?
In general, most lenders won’t consider your refinancing loan application if you have a loan-to-value ratio (LVR) of more than 80%. However, some lenders may consider refinancing borrowers owing more than 80%, though you’ll most likely need to pay LMI.
To give an example, if you want to refinance a property worth $500,000, your home’s equity needs to be at least $100,000 to avoid paying LMI.
This is one of the main barriers to getting equity loans for property investors (and even aspiring home buyers) who have low equity. If you want to refinance but have less than 20% equity, make sure you’re aware of the LMI costs you’re facing and that the cost justifies your reason for refinancing. If you’re not sure about the level of equity in your home or investment property, you could use an equity calculator to give you an idea.
Are the costs of refinancing an investment property loan tax-deductible?
For property investors, some refinancing costs can be claimed at tax time, though there are specific rules around determining tax deductibility.
What you can claim as a tax deduction
These are the initial costs of refinancing — some of these may include:
- loan application fee
- mortgage discharge fee or loan exit fee
- cost of getting your property valued
- title search fee
- fees potentially charged by mortgage brokers (on top of any commission)
- LMI
- loan registration costs
- break costs (not applicable to variable rate loans)
When to claim tax deductions for the costs of refinancing?
These costs are generally considered to be borrowing expenses. If the borrowing expenses you are claiming are under $100 in total, they can be claimed in the same financial year you incurred them. Otherwise, they can be claimed as a tax deduction over a five-year period or over the loan term (whichever is shorter).
However, if the mortgage is repaid in full within that time period, the remaining tax deductions can be claimed in the same year. As a general rule, expenses related to the discharge of a mortgage can be claimed in the year they were incurred.
What you can’t claim as a tax deduction
If you’re refinancing to buy an investment property, stamp duty is not tax-deductible as it is considered a ‘capital expense’, or expenses you incur when buying or selling an investment property. You also can’t claim associated costs if you’re refinancing your home loan, as the home that you live in isn’t used to produce an income.
It’s a good idea to keep records of your rental income and expenses related to your rental property to help make tax returns easier, particularly if you have a negative gearing strategy. Before refinancing an investment loan, it’s important to consult with a tax professional to determine which refinancing costs can be claimed as tax deductions.
Are there any tax implications when refinancing?
There may be tax implications when refinancing an investment property, but it can vary depending on the specific circumstances. Here are some of the most common refinancing scenarios and what you should know on a high level for each.
Draw equity for your investment property — If you refinance an investment property loan and release equity to spend on your investment property (such as by making renovations), the interest on the loan used to fund those expenses may be tax-deductible.
- Conversely, if you refinance your home loan and get a home equity loan to buy an investment property, the interest for the additional loan may be tax-deductible. This is because the purpose of the funds is related to real estate that generates rental income. But you can’t claim interest on the remaining portion of the loan that’s associated with your owner-occupied home.
Draw equity for personal use — If you refinance and release equity for personal use (for example, to buy a home to live in or to renovate your home), those funds are considered to be for a private purpose. This means you typically can’t claim interest on that portion of the loan as a tax deduction.
Refinance without drawing equity — If you refinance an investment property and do not take out any cash (for example, to switch to a lower interest rate), the tax implications will generally be the same as when you first took out the original investment loan. Provided the loan is used for the rental property, the interest on the new mortgage may be tax-deductible.
Convert rental property to non-rental property — If you refinance and change the use of the property from a rental property to a home or holiday home, the interest on the new home loan may not be tax-deductible.
Convert non-rental property to rental property — On the flip side, if you refinance and change the use of a home to a rental property, the interest on the new investment loan may be tax-deductible.
It’s always best to consult with a tax professional for advice specific to your circumstances. They can help you understand the tax implications for your personal situation and help you make informed decisions about refinancing your home or investment property.
What credit score is needed to refinance a rental property?
There’s no doubt that a decent credit score can go a long way in helping you refinance your investment loan. But for property investors exploring refinancing as an option, navigating Australian credit score requirements can be tricky, especially for those with bad credit.
For starters, the credit assessment system can vary depending on the lender and lenders don’t usually publicise their credit criteria. That means qualifying with one lender doesn’t necessarily mean you’d qualify with others, so there’s no magic number that guarantees approval. To make matters more complicated, there are three major credit reporting bodies in Australia — Equifax, Illion, and Experian — all of which use different credit scoring methods and benchmarking systems.
Broadly speaking, more established lenders require a higher credit score when looking at refinance applications while the criteria used by smaller lenders are often less strict. In fact, some small lenders may not even consider your credit score, instead placing more emphasis on other parts of your application.
Some might think an easy solution is to make multiple refinancing applications with different lenders. However, this is not advised as when you refinance, you’re effectively requesting a new loan, which will be reflected on your credit report and can affect your credit score. If you frequently apply to refinance, lenders may become hesitant to approve your future loan applications.
Is it worth it to refinance an investment property?
Refinancing an investment has its pros and cons just like property investing, so whether you should refinance depends on your goals and individual circumstances. If you’re seeking to switch to a low rate to reduce mortgage repayments, you should make sure the numbers stack up in your favour. Consider using a loan calculator to compare loan repayments across different loan types and loan options.
But refinancing isn’t necessarily an option for everyone. For example, if you’re on a fixed rate, have a high LVR or if your property has decreased in value, it might be wise to think twice before refinancing. While a loan refinance is one way to access equity, it may not always be the best way.
As a smart investor, if you're considering refinancing an investment property, it's important to weigh up the costs against any potential financial benefits. Refinancing can be complicated, so it's important to do your research before deciding. It may be helpful to speak with a mortgage broker or financial advisor to understand whether refinancing is a good option for you.
