Interest-only investment loans can be a smart tool for savvy property investors. Compare investment loans and apply today.
If you’re investing in property, a popular strategy is to take out an interest-only investment loan. Many investment loans offer an interest-only option and provided you’re disciplined and use it properly, it can be an effective strategy for maximising your returns on an investment property.
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What is an interest-only investment loan?
An interest-only investment loan is a mortgage product that allows you to repay only the interest portion for a set period, usually up to five years.
When you make repayments on a traditional home loan, your repayment is split into two portions. A portion of the repayment goes toward paying for interest charges while another part goes toward reducing the principal, or the original amount you borrowed.
By contrast, an interest-only investment loan only requires interest payments. This means your repayment goes toward interest charges, but without reducing the loan’s principal. At the end of the interest-only period, you’ll still owe the same amount on your home loan.
This also means that your monthly repayments are lower. By subtracting the portion that would usually go toward reducing your mortgage principal, you’ll significantly lower your repayments.
How can property investors take advantage of these loans?
There are several ways investors can use interest-only investment loans to their advantage.
1. Tax minimisation
Investors usually use interest-only loans to reduce their tax bill. Here’s how it works.
For property investors, home loan interest is tax deductible. 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, this means you can maximise your tax deductible debt. You’ll be able to deduct your entire home loan repayment from your taxes because you're only paying interest.
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 during the interest only period.
This can be a risky strategy, but given the astronomical price growth in many Australian suburbs and cities in recent years, it's a potentially lucrative one. But you do need to do your research.
What are the risks of interest-only loans?
Interest-only loans have a few possible drawbacks:
- With all 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.
- Finally, these home loans are also becoming more difficult to get. The Australian banking regulator APRA has required banks to cap interest-only lending at 30% of new lending. This means there is a limited supply of interest-only home loans.
How do I compare interest-only investment loans?
When comparing interest-only home loans, the first priority is to look at the interest rate. Since this will determine the repayments you’ll be making, it should be your first point of comparison for interest-only products.
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.
Compare by features
You can also compare interest-only home loans from their features. For instance, some interest-only home loans include offset accounts. An offset account reduces the amount of interest you pay. It’s a linked transaction account that reduces the amount the interest is calculated on by the funds in the account. In other words, if you have a $500,000 home loan with $50,000 in an offset account, interest will only be calculated on $450,000. For an interest-only home loan, this can be a handy tool to reduce your repayments.
Can you split your rate?
You may also want to look for features like a split facility, which allows you to split your loan into fixed and variable rate portions. This means a portion of your loan will be insulated from rate rises, while another portion could potentially benefit from rate decreases.
Interest-only home loans can be an effective tool for investors, but they’re only effective if they’re used responsibly and with a long-term strategy in place. Make sure you budget for principal and interest repayments and take into account all the potential risks before you choose one of these products.
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