Refinancing is probably the biggest, most complicated, and (often) most stressful financial decision you can make as a property investor.
Yes, there are a lot of reasons to do it. You might be able to reduce your interest rate or even release equity, but there are often competing objectives you’ll need to balance, hurdles you’ll need to navigate and tax implications to consider.
This might sound like a lot to navigate but we’re here to make it simple. In this guide, we give you the seven key refinancing tips so you can make an informed decision about when refinancing makes sense.
1. Start with ‘why’ refinance your investment property loan
Whether you should refinance your investment property loan probably boils down to the ‘why’ - what are you solving for? While we don’t provide financial advice, the following is a list of some of the key reasons people consider refinancing - some of which make sense, and some of which don’t make sense, depending on your objectives.
a) Continue investing in property
If you’ve built up a lot of equity in your property, a cash-out refinance could give you extra cash to buy, or put down a deposit on another property. That could mean additional rental income and extra capital growth.
The complexity arises when you need to consider whether refinancing to cash out the money you need for your next deposit aligns with your long term debt and portfolio strategy. For example you’ll need to move onto a loan that is going to charge you a higher interest rate on your entire loan balance, the incremental cost of accessing that money might be much more than you initially realise and limit your ability to continue to borrow and grow your portfolio.
As an example, if you’re going to cash out $100K by topping up your mortgage from $500K to $600K but that results in the interest rate on your loan increasing by 0.5%, that will mean an additional $139K in interest over a standard 25 year term. It will also reduce your borrowing capacity by around $150K for the next 25 years. Here’s a break down of the numbers so you can see it for yourself:
c) Lowering your ‘cost’
The most common reason people refinance is to get a better interest rate and most people do this because they want to ‘save’ money.. While this makes sense at a high level, it’s worth digging deeper into your main objective given a few competing priorities:
- Borrowing capacity vs interest cost: if your main objective is lowering your interest rate, it might mean borrowing less money so that the banks see you as a lower risk borrower and therefore charge you a lower interest rate. You’ll need to weigh up the pros and cons of borrowing more money at a higher interest rate vs. borrowing less money at a lower rate but not being able to access as much finance.
- Lower interest vs. lower cost: while these might sound like one and the same, they are often the complete opposite. For example, let’s say you have a $500,000 mortgage and are 5 years into a 25 year principal at interest loan, let’s assume interest rates have come down and you might be thinking that by refinancing onto a 0.5% lower rate it might save you some money - this might be right if you don’t start a new 25 year loan, but if you refinance into a new 25 year loan it might actually end up costing you another $51,420 in interest. Here’s the numbers:
- Lower payments vs. lower cost: aside from interest rate and term, which are explained above, another big needle mover is being on a principal and interest loan vs. an interest only loan. While you might be paying less on a monthly basis on an interest only loan, the absolute dollar figure in interest you are paying will be significantly higher than if you had a principal and interest loan and this is before even factoring in the likely lower rate that you’ll be on if you are on a principal and interest loan.
- The three other significant considerations are: Lenders having minimum equity requirements, typically at least 20%. If you don't have enough equity, you may need to pay lenders mortgage insurance (LMI) when refinancing. Use an LMI calculator to see how much you might have to pay.
- If you're on a fixed rate, lenders may charge a break cost if you exit the loan before the fixed period ends. If those costs outweigh what you save by switching to a lower rate, you may not get the lower monthly repayments you want. A repayment calculator may be useful here.
- Lenders often have long application processes and complex eligibility criteria. You may need to provide extra documentation and wait a long time before you see your money.
Before refinancing, compare home loans and rates across different lenders to understand your options.
2. How Soon Can You Refinance an Investment Property?
You can generally refinance your investment property as soon as you like. But just because you can, it doesn't mean you should.
Aside from potential costs like LMI and break fees, you should also consider:
- Serviceability — You’re essentially trying to replace your existing loan with a new one. Your new lender will want proof that you have a steady income and a good history of paying on time. They'll also want to know your loan amount is not more than your investment property’s value.
- Changes in circumstances — If your personal or financial situation changes, your refinancing application may be less straightforward. For example, if one spouse takes a career break or if you’re approaching retirement, lenders may question whether you can afford the new loan, as well as your borrowing power.
- Refinancing costs — Some expect to save thousands in loan repayments by refinancing, but the reality there can be costly upfront charges. It’s best to check with your new and existing lender to understand your exact costs.
- 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 rate, it makes sense to calculate how much you’re actually saving compared to your existing deal. You may also lose handy features, like offset accounts, when switching.
- Turnaround time — Lenders are known to prioritise new home loan applications over refinances, so expect to wait 1-3 months. Depending on how you use your unlocked equity, this delay can hold back your plans.
- Tax implications —If you’re refinancing to draw equity for personal reasons, there may be tax implications (more below).
Timing can be everything. How refinancing impacts your long term debt and portfolio strategy can significantly outweigh the optics of a lower rate if it means you end up paying more interest and can’t continue to grow your portfolio.
3. How Much Equity Do You Need to Refinance an Investment Property?
Most lenders won’t consider your application if your loan-to-value ratio (LVR) is more than 80%. For lenders, a high LVR means higher risk if you default or the market crashes. That usually means they charge a higher interest rate or expect you to pay LMI.
For example, if you want to refinance a property worth $500,000, your home’s equity usually needs to be at least $100,000 to avoid paying LMI.
That’s no small barrier. If you want to refinance but have less than 20% equity, make sure you’re aware of the LMI costs and that the cost justifies refinancing. If you’re not sure about your equity, use an equity calculator to give you an idea.
If your LVR is high, you could invest in improvements to increase your property’s value. You could also overpay on your repayments. This reduces your debt and the total interest you pay, but some lenders will charge you for overpaying, so make sure you know all the costs before you start.
4. Are Refinancing Costs Tax-Deductible?
As an investor, you can claim some refinancing costs when you submit your tax return (usually between July and October), though there are rules around determining tax deductibility.
What you can claim as a tax deduction
Of the initial refinancing costs, you may be able to deduct some, or all, of your:
- Loan application fee
- Mortgage discharge fee
- Loan exit fee
- Valuation Costs
- Title search fee
- Mortgage broker fees
- LMI
- Loan registration costs
- Break costs (not applicable to variable rate loans)
When do you claim tax deductions for the costs of refinancing?
Refinancing costs are generally considered to be borrowing expenses, i.e. the cost of obtaining, financing, or discharging a loan to purchase your investment property. The property must be for producing income, not for you to live in.
If the borrowing expenses you are claiming are under $100 in total, you can claim them in the same financial year you incurred them. Otherwise, you could claim them as a tax deduction spread equally over a five-year period or the loan term (whichever is shorter).
If the mortgage is repaid in full within that period, you may be able to claim the remaining tax deductions in the same year. Generally, 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
Obviously, not everything is tax deductible, for example:
- When refinancing to buy an investment property, stamp duty isn’t tax-deductible as it is considered a ‘capital expense’, or expenses you incur when buying or selling an investment property.
- You can’t claim associated costs if you’re refinancing your home loan, as you’re not using the home you live in to produce an income.
- If you refinance and the proceeds from the refinance are used for personal reasons like a family vacation, the interest on the money you used for personal purposes isn’t tax deductible.
- If you split the loan for personal and investment purposes, you can only deduct the interest on the portion that you invested.
It’s a good idea to keep records of your rental income and expenses to make tax returns easier, particularly if you have a negative gearing strategy.
Finally, remember that depreciation, administration, and maintenance could all be deductible too. The ATO provides comprehensive rules on what is and isn’t deductible, but consult with a professional to determine which costs you can claim.
5. Tax Implications When Refinancing an Investment Property
Refinancing an investment property affects your tax return, but it varies depending on your circumstances. Here are some common refinancing scenarios and what you need to know.
Draw equity for your investment property
If you refinance an investment property loan and release equity to spend on your investment property (e.g. for renovations), the interest on the loan may be tax-deductible. For example, if you accrue $4,000 in interest from your $40,000 loan in one year, you could claim the $4,000.
If you take out a home equity loan to buy an investment property, the interest may still be tax-deductible because the funds are related to real estate that generates rental income. But you can’t claim interest on any portion of the loan associated with the property where you’re living.
Draw equity for personal use
If you refinance and release equity for personal use (for example, buying or renovating the home you live in), those funds are classed as for a private purpose. This means you typically can’t claim interest on that portion of the loan as a tax deduction.
For example, if you spent $25,000 on an investment and $25,000 on a new car from a $50,000 cash-out refinance, you may be able to claim half the interest as tax deductible, but not all of it.
Refinance without drawing equity
If you refinance an investment property without taking out any cash (for example, to get a lower interest rate), the tax implications are generally 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.
For instance, say your outstanding balance on your rental property is $100,000 and you were paying $9,000 per year in interest. If you switch to a lower interest rate, with the same-sized mortgage, that reduces the interest to around $7,500, so you have $7,500 of tax-deductible expenses.
Convert rental property to non-rental property
If you refinance and stop renting your property out so that it can be your home or holiday home, the interest on the new loan may not be tax-deductible. That’s because you’re now using it for personal reasons.
For example, Haashym has a property by the coast that he’s been renting out but which he now wants to use for vacations with his family. He was previously claiming $15,000 per year in interest as a tax-deductible expense, but he stops now that he’s not renting it out.
Convert non-rental property to rental property
On the flip side, if you refinance and start using your home as a rental property, the interest on the new loan may be tax-deductible. So, if Haashym has had enough of beach vacations and decides to switch back to renting the property out, he can start claiming the interest again,
It’s always best to keep clear records and consult with a tax professional for specific advice on the implications for your personal situation, helping you make informed decisions about refinancing.
6. Credit Score Requirements for Refinancing Rental Properties
A decent credit score goes a long way in helping you refinance. But for property investors, navigating Australian credit score requirements can be tricky.
For starters, the credit assessment system varies depending on the lender and lenders don’t usually publicise their 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, Australia has three major credit reporting bodies — Equifax, Illion, and Experian — all of which use different methods and benchmarking systems.
Broadly, more established lenders require a higher credit score for refinance applications while smaller lenders are often less strict. In fact, some small lenders may not even consider your credit score, instead focusing on other factors.
You might think an easy solution is to apply with lots of different lenders, but beware. Every application potentially drags your score down lower. Lenders are more hesitant if you’ve filled out lots of applications in a short time.
Another common pitfall is not improving your score. If you pay your bills on time, monitor your credit reports for errors, and pay off high-interest debts like credit cards and short-term loans, you can get your score up and improve your chances of getting finance.
7. Is It Worth Refinancing Your Investment Property?
Don’t assume that refinancing is the only option, especially if your objective is to release equity for renovations or new properties. As we explain elsewhere in more detail, refinancing isn’t always the best option. Refinancing your long-term debt to solve a short or medium term need might not be the best solution.
To decide if a cash-out refinance is right for you, ask yourself:
- What’s the real cost of interest in dollar terms over the life of my loan?
- How will this impact my overall purchasing power and ability to meet my long-term property goals?
- How will this impact my tax?
- How will this impact my cashflow?
- How long will this take and what is the opportunity cost involved in locking this in now?
If, based on this framework, you decide that cash-out refinancing doesn’t make sense, you might consider Futurerent as an alternative.
Benefits of Using Futurerent Instead of Refinancing
Rather than adding to your debt, Futurerent gives up to $100K of your rental income now - that's seamlessly returned from just a portion of your tenant's rent. . You could have approval in two business days, so the process is much faster. On top of that, there’s no impact to your credit score and much less paperwork. That means fewer delays.
There are no hidden costs either. Futurerent receives a fixed portion of your rent, and the fee is set from the beginning, so there’s no nasty surprises with interest rate rises.
Real-Life Example
Here’s an example. David wanted to refinance his $800,000 investment property to release $75,000 for a second purchase. Instead of paying break costs and LMI, he used Futurerent to access $75,000 of rental income without altering his loan. The results:
- David got his money in two business days, meaning he could crack on with his second purchase.
- His credit score stayed at the high level he’d worked hard to achieve.
- He didn’t have to refinance his loan or change his long term debt strategy.
Refinancing an investment property loan is a complex and potentially long process. There are a lot of steps to understand if you can or should refinance, and depending on your objectives you might go about it in completely different ways.
But whether you’re looking to reduce your monthly outgoings or invest in your portfolio, the hoops you have to jump through and the paperwork stay the same. If you go ahead, it’s vital that you’re aware of the pitfalls laid out in this guide, both in the application and when it comes to costs and taxes.
How Does Futurerent Impact Tax?
Futurerent has obtained a product ruling from the Australian Tax Office (ATO) to make things easy come tax time. At the end of each financial year, Futurerent will provide a statement showing the rent collected by Futurerent and your indicative accrued rent (see paragraphs 15(b) and 15(c) of the product ruling).
The statement is intended to assist you in filling out your tax return and does not constitute tax advice. Futurerent does not provide taxation advice. You should review the product ruling for more information and seek your own tax advice on the application of the product ruling to your own specific circumstances. If tax laws change or if the Commissioner of Taxation withdraws the product ruling, it may result in different tax outcomes than those described in the product ruling. You can get a copy of the product ruling here, or contact us at hello@futurerent.com.au for a copy of the product ruling (free of charge).
Please note that the product ruling from the Australian Tax Office:
- is only a ruling on the application of taxation law
- is only binding on the ATO if the Scheme is implemented in the specific manner outlined in the product ruling.
- The Commissioner of Taxation (Commissioner) does not sanction, endorse or guarantee this product. Further, the Commissioner gives no assurance that the product is commercially viable, that charges are reasonable, appropriate or represent industry norms, or that projected returns will be achieved or are reasonably based.
- Potential participants must form their own view about the commercial and financial viability of the product. The Commissioner recommends you consult an independent financial (or other) adviser for such information.
While everyone’s individual circumstances are different and we cannot give tax advice, a general example of an investor who gets $30K upfront from Futurerent is laid out in the table below. The investor gets the $30k upfront but is taxed progressively over time and only taxed on the rental income they are receiving net of rent that is going to Futurerent i.e. $27,660 of income each year instead of $30,000.
Put simply, by using Futurerent instead of borrowing money, the client in this example has reduced their taxable income by $2,340 per year irrespective of what the $30,000 was used for - all without taking on a loan or the mountain of paperwork that goes with it.
Want a simpler way to unlock equity from your rental property? Find out how Futurerent can help you fund your next move without refinancing.
FAQs
1. Can I refinance if I have less than 20% equity in my investment property?
Yes, but most lenders will require you to pay Lenders Mortgage Insurance (LMI) and typically higher interest rates.
2. How does refinancing affect my rental property’s tax deductions?
Refinancing and interest costs may be tax-deductible if the money is used for investment purposes. However, interest and expenses related to personal use or properties you live in aren’t deductible.
3. What are the alternatives to refinancing for property investors?
Offset accounts let you use your savings to reduce your interest payments. Alternatively, Futurerent lets you cash out up to 100K from your investment property without selling or dealing with the banks.
