If you’re investing in property, an interest-only investment loan can help you build wealth while minimising costs. If not used correctly it can cost you more in interest repayments.
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The loans below have interest only repayments. However, the repayment calculation shows principal and interest repayments. Your initial repayments will be lower.
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What is an interest-only investment loan?
An interest-only investment loan is a mortgage that allows you to repay only the interest portion for a set period, usually up to five years.
This means your monthly repayments start smaller. Why? Because you're not repaying the money you've borrowed (the principal). You're just paying the interest on top.
It saves you money in the short term but will cost you more in the long term because you pay more interest over time.
If used correctly an interest only investor mortgage can help you minimise your tax and repayments. But you need to be aware of the potential downsides too.
To fund your investment property and repay the loan in full you should look at an investor mortgage with principal and interest repayments.
How can property investors take advantage of these loans?
There are several ways investors can use interest-only investment loans to their advantage:
Tax minimisation
Negative gearing
High capital growth strategy
1. Tax minimisation
Investors usually use interest-only loans to reduce their tax bill because home loan interest is tax deductible for investors. At the end of the year you can deduct all the interest charges you’ve paid for your investment property over that year. Payments on the loan principal, meanwhile, aren’t deductible.
If you’re a property investor using an interest-only home loan you’ll be able to deduct your entire home loan repayment from your taxes.
2. Negative gearing
Interest-only investment home loans can be a particularly effective strategy when you account for negative gearing. Negative gearing is a tax concession that allows you to offset any losses you make on your investment property against your personal income. In other words, if you pay more maintaining your investment property and servicing the debt on it than you bring in from rental income, you can deduct this loss from your personal income.
Typically, this strategy is used to minimise losses on an investment property while you wait for the property to appreciate in value. The idea is to eventually sell the property for a capital gain, while minimising the cost of holding the property in the meantime.
3. High capital growth strategy
Some investors buy property with a high-growth strategy by choosing properties and locations they believe will grow quickly in value. Rather than holding the property for many years, renting it out and paying it off over time, these investors buy the property, try to minimise their repayments for a few years, then sell the property for more than they paid. For this strategy to work, an interest-only investment loan is essential because your repayments are much smaller at first.
This can be a risky strategy. It worked well for many investors when property markets were booming. When markets are down it's a different story.
What are the risks of interest-only loans?
Interest-only loans have a few possible drawbacks:
With interest-only loans you won’t reduce your debt during the interest-only period. At the end of the interest-only period, you’ll still owe the same amount you borrowed.
Your repayments rise significantly once your loan reverts to a principal and interest loan. You need to prepare for this in advance.
Going with an interest-only investment loan means you'll end up paying more over the life of your home loan. Since you won’t be reducing the principal on your home loan, it will likely take longer to pay off your mortgage, increasing the interest you pay in the long run.
Interest-only home loans can also be risky if your property fails to increase in value. This means when the interest-only period ends, you won’t have equity in your home.
How do I compare interest-only investment loans?
When comparing interest only mortgages for investment, you need to consider these factors:
Rate. A lower rate means lower repayments. It's one of the fastest ways to compare mortgages.
Offset account. Having an offset account lets you use additional savings to reduce your interest payments even further. Read this guide to learn more about this strategy.
Flexibility. A loan with low fees (especially discharge and switching fees) makes it easier to refinance your mortgage when the interest only period ends. And why pay more in fees when you can avoid it?
Use a repayment calculator
Use the calculator below to find out what your repayment will be if you choose an interest-only home loan. Then run the same calculations for principal and interest repayments so you can see what your repayments will be once the interest-only period ends. You’ll need to pay attention to both repayment figures and determine if you’ll be able to service the new repayments once your interest-only period ends.
Adam Smith was the home loans editor at Finder, covering the Australian property market and any news affecting Aussie mortgages. He has been writing about home loans and property for more than eight years. He also has a home loan of his own, so has a vested interest in finding the best deals.
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