When is an interest-only investment loan the right choice?

Investing in property can be a financial juggling act, but it can secure your wealth if you get it right. There are the initial outlay, repayments, fees, insurances and midnight calls from tenants with flooded apartments.

Interest-only investment loans are one-way landlords are keeping costs down. Without the need to repay the capital, the monthly payments are lower than for principal-plus-interest loans. It helps to maximise cash flow while continuing to benefit from capital growth. Plus, the extra dosh could mean a deposit on that sweet fixer-upper across town.

Interest-only investment loans can also be advantageous at tax time. If applicable, the interest you are paying can sometimes be offset against rental income and other eligible property costs. Investors who opt for interest-only repayments on a fixed-rate loan may also be able to claim a tax break for up to twelve months of prepaid interest.

There are heaps of factors to consider before taking out an interest-only loan. Is it the right choice for you? It is worth discussing with your accountant or the financial planner as well.

Be wary of a false economy

A lower monthly payment can make an investment property seem more affordable. However, while you’re not paying off the principal, the amount of interest you’re up for will always be higher.

The Australian Securities and Investments Commission (ASIC) has broken down this cost over time. For example, they found that on a $500,000 loan with a rate of 6%, a borrower making principal plus interest repayments would pay total interest costs of $579,032 over a 30-year term. By contrast, if a borrower opted to make interest-only payments for just five years out of the same 30-year loan, the long-term interest bill would rise to $616,258 – that’s $37,226 more than the alternative.

Some interest-only loans also come with higher interest rates. Shop around to make sure you’re not worse off.

Know what you’re buying

While you’re making payments on an interest-only loan, you’re not reducing the principal at all. At the end of the loan term, you won’t ‘own’ any more of the property than you did at the beginning. You will still owe the full balance of the mortgage.

Depending on how the market is performing, your property may be worth a lot more than what you paid for it – or a lot less. If the capital growth doesn’t cover the cost of selling, you could be facing a net loss, and that could put a substantial dent in your plans for your next property.

It’s probably not long-term

You may be planning to turn over your investment property within five years. If not, you might be subject to a massive payment increase down the track. Most of these loans offer an interest-only period, after which the loan structure will be reverted to the interest-and-principle version. That means you will start paying interest on the full amount, which can come as a bit of a shock to the budget.

You may have the option to build equity another way: with an offset account. Making extra payments into a linked account will give you the buffer you would relying on to get from property equity. And because it is ‘bonus’ money on top of your interest-only payments, it will be available to redraw for further investments.

Choosing home loans with interest-only payments can help you get your foot in the door sooner. Before you sign, discuss with your accountant or financial planner about how much it will cost you over time. Once you assessed your cost analysis with the accountant, reach out to your local finance broker to assess your borrowing capacity and best-suited loan product to your financial goal.

This article is prepared based on general information. It does not take into account individual financial objectives or needs and is not financial product advice. The original content is first published online at https://www.mebank.com.au/the-feed/interest-only-loans-the-right-choice-for-investors/?utm_source=shareme7&utm_medium=email&utm_campaign=shareme&utm_content=shareme7_INV

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