As the regulatory environment for lending shifts to maintain stability in the economy, the amount if interest- only loans approved has dramatically decreased. Regulatory changes have made interest-only loans costly for property investors, making principal and interest loans a more popular route. This, however, hasn’t always been the case.
The trend about 10 years ago was for advisers and brokers to recommend interest-only investor loans as only the interest is tax deductible. At the time it was viable to go down this path as a means to free up cash flow and maximise tax deductions.
With the shifts that have occurred in the economy since then, however, more investors are securing property with a principal and interest loan.
With a principal and interest loan, borrowers usually benefit from a lower interest rate compared to interest-only loans. The borrower also reduces the amount they owe immediately through making principal repayments. These factors, coupled with today’s lending environment, are making principal and interest loans the most viable financing option, saving them money from the first year of their loan.
Here’s an example (Adapted from API Magazine: Why Interest Only Loans No Longer Make Sense):
Sally earns a salary of $118,000 per year and she wants a loan of $544,000 to purchase an investment property worth
$680,000. She plans to rent out the property at $300 per week.
Sally is considering her options — an interest-only loan at a rate of 4.3 per cent or a principal and interest loan at 3.89 per cent.
If Sally picks an interest-only loan:
- Sally would have an additional $937 tax benefit from an interest-only
- The monthly mortgage repayments would be lower
- In the first year, however, Sally would pay an extra $2,403 in interest
If Sally picks a principal and interest loan:
- Sally will pay $9,764 off her investment property home loan in the first
- This equates to a net benefit of $3,865 in the first year compared to the interest-only
- Over five years, this equates to an additional $25,803 paid off the loan principal.
The choice to save on interest and fees, while paying down the loan principal as shown in the example above is becoming an increasingly popular option for property investors as the interest-only lending environment for investors continues to shift.
Remember, the example above is for information purposes only. You should consult a finance professional to discuss your specific circumstances before making financial decisions.