Holiday Home Loans: What Not to Do Before You Apply

The most costly holiday home mistake is choosing the property before you know how the loan will be structured.

For buyers in Bass, the Bass Coast and Phillip Island are close enough to make a second property feel within reach. The finance behind it needs as much thought as the location. A holiday home usually sits on top of your existing debts, so the way you set up the new loan affects your whole financial position. This article covers what to sort out before you make an offer.

What Does a Holiday Home Loan Involve?

A holiday home loan is a home loan secured against the holiday property, and sometimes against your current home as well. The lender assesses it alongside every debt you already have.

Lenders can treat a holiday home differently from the home you live in. Some may class it as owner occupied, while others may assess it more like an investment property. Their rules, pricing and deposit requirements vary. A home loan rates comparison done only on headline numbers can miss this. Ask which loan type applies to your situation before you compare lenders.

How Much Can You Borrow for a Holiday Home?

Your borrowing capacity for a second property is usually lower than it was for your first, because the lender counts your existing repayments and living costs. It also depends on your income and any other debts, such as credit cards.

Our borrowing capacity page explains the factors lenders weigh. The practical step is to get home loan pre-approval before you inspect properties. Pre-approval gives you a working budget, so you are not bidding on something the lender later declines to fund. It is not a final commitment, and the lender will still assess the specific property and your circumstances before formal approval.

Reducing credit card limits you no longer use can also help, because lenders often assess the limit rather than the balance.

Using Home Equity as a Deposit: Know the Trade-Off

You may be able to use equity in your current home as the deposit for a holiday home, but it depends on lender approval, an acceptable valuation and whether your income can service the total debt. Equity is not the same as borrowing capacity. Both properties may be tied to the lender if they secure the same loans (known as cross-collateralisation). If one loan runs into trouble, the other property can then be affected.

The loan to value ratio (LVR) compares the loan amount with the property's value. A higher LVR generally means a higher risk for the lender. Depending on the lender and your deposit size, Lenders Mortgage Insurance (LMI) may be added when the deposit is small. LMI is a cost you pay, and it protects the lender rather than you.

A common way to manage the risk is to take a separate loan for the holiday home that is secured only by that property, rather than bundling the loans together. Your broker can explain how each lender handles this, and the structure is worth settling before you sign a contract.

Interest Only or Principal and Interest on a Holiday Home

Interest only repayments are lower in the short term, but you do not reduce the loan balance during that period. Principal and interest repayments cost more each month and pay the debt down from day one.

As an illustration, consider a buyer borrowing $500,000 over 30 years at an example rate of 6.75% p.a. This rate is for illustration only and is not a current offer.

• Principal and interest: about $3,243 a month.
• Interest only: about $2,813 a month, roughly $430 less.

The saving looks appealing, but the interest only period ends. If this buyer took five years of interest only and then switched to principal and interest, the loan would need to be repaid over the remaining 25 years. At the same 6.75% example rate, repayments would rise to about $3,455 a month. That is higher than if the buyer had paid principal and interest from the start.

A buyer in this position might choose principal and interest to avoid a payment jump later, but the right choice depends on their budget and plans. Interest only can still suit some buyers, for example when the plan is a short holding period. The trade-off is that the balance does not fall, and you pay more interest over the full loan. Repayment figures change with the rate and term, so test your own numbers in a repayment calculator.

Variable, Fixed or Split Loan for a Second Property

A variable rate moves with the lender's decisions, a fixed rate stays the same for a set period, and a split loan divides the balance between both. Each has a cost.

A variable rate usually allows extra repayments and an offset account. The downside is that repayments can rise. A fixed rate gives certainty, but it can limit extra repayments and may carry break costs if you exit early. A split loan spreads the risk, though it can mean managing two repayment amounts and fewer features on the fixed portion.

An offset account is worth a look if you plan to build savings for upkeep, rates and insurance. Money in the account reduces the interest charged on the linked loan. Some lenders charge a package or annual fee for it, so check that the benefit outweighs the cost. If your fixed rate is ending on your current home, our fixed rate expiry page covers what to review first.

Renting Out a Holiday Home: Check the Loan Type and Tax First

If you plan to rent the property out, tell your broker at the start, because it can change the loan type and how the lender assesses your application.

A holiday home that earns rent may fall under investment loans rather than a standard home loan. Lenders may count some of the expected rental income, but they will apply their own policies. Holiday letting income can also be irregular.

Tax treatment depends on how much the property is used privately and how much it is rented. Speak to your accountant before you buy and before you make any assumptions about deductions. No tax outcome is certain until your accountant has reviewed your circumstances.

If you already hold loans and want to know where you stand before taking on more debt, a loan health check is a sensible first step. You can also read about our local service on the Bass mortgage broker page.

Call one of our team or book an appointment at a time that works for you, and we will work through your borrowing capacity, loan structure and lender options before you make an offer.

Frequently Asked Questions