Published at: 8/26/2016 10:39:39 AM
A recent report by the government’s money watchdog sheds light on the unexpected cost of interest-only loans.
Property investors have often favoured interest-only loans - and with good reason.
Without the need to repay capital, the monthly payments on interest-only loans are lower than for principal plus interest loans. This helps to maximise an investor’s cash flow, and the extra free cash can be used to fund other properties and expand an investor’s portfolio.
Interest-only loans can also be highly tax efficient. The loan interest can sometimes be offset against rental income (plus other eligible property costs) when working out your tax bill. Investors who opt for interest-only repayments on a fixed rate loan may also be able to claim a tax break for up to 12 months of prepaid interest.
Reflecting these benefits, ME’s Basic and Flexible Home Loans are both available as interest-only options.
The catch of interest-only payments
The lower monthly payments of an interest-only loan can also, on the face of things, make an investment property appear more affordable. However our investment regulator - the Australian Securities and Investments Commission (ASIC), has warned that this may be a case of false economy.
The catch lies with the way the loan balance remains the same when an investor chooses to make interest-only payments.
ASIC found for example 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 with principal plus interest repayments. Opting for interest-only payments for 10 years, would further push out the overall cost difference to $80,720.
Food for thought for investors
Of course not all investors want to hold onto their property for the full term of their loan. But ASIC’s findings are worth thinking about if you plan to be a long term investor. Yes, interest charges are typically tax deductible for property investors, but managing costs plays a critical role in achieving healthy returns over time.
 ASIC media release: 15-220MR Lenders to improve standards following interest-only loan review, 20 August 2015 https://www.asic.gov.au/about-asic/media-centre/find-a-media-release/2015-releases/15-220mr-lenders-to-improve-standards-following-interest-only-loan-review/
Credit criteria, conditions, fees and charges apply.
Members Equity Bank Ltd. ABN 56 070 887 679. AFSL and Australian Credit Licence 229500.