Investing in property can be a financial juggling act. There’s the initial outlay, repayments, fees, insurances... and then midnight calls from tenants with flooded apartments (have a good plumber's number handy).
But when it comes to finances, an interest only investment loan is one way that landlords can keep costs down.
What is interest only and what are the benefits?
Without the need to repay capital, the monthly payments with an interest only mortgage are lower than for principal-plus-interest loans. This 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.
As well as lower repayments, interest only home loans can also be great at tax time. The interest you’re 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 might also be able to claim a tax break for up to 12 months of prepaid interest. As an investor, you could also claim higher tax deductions from an investment property. Nice one.
But before taking out interest only loans for investment properties, make sure they’re right for you.
Be wary of a false economy when considering an interest only loan
Lower monthly repayments can make an investment property seem more affordable. But 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 actually worse off.
Understanding an interest only home loan
While you’re making payments on an interest only loan, you’re not actually 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 serious dent in your plans for your next property.
Interest only home loans aren't forever
You may be planning to turn over your investment property within five years. If not, you might be subject to a big payment increase down the track. Most of these loans offer an interest only period, after which you’ll be reverted to the interest-and-principle version. That means you’ll 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’d normally get from property equity. And because it’s ‘bonus’ money on top of your interest only payments, it will be available to redraw for further investments.
It's a good rule of thumb to work out what the cost of your repayments will be at the end of the interest only period, and to make sure you can afford to make the higher repayments. Use our Interest Only Home Loan Calculator to make the best decision for your financial situation
Choosing home loans with interest only payments can help you get your foot in the door sooner. Before you sign, speak to your lender about interest only investment loan rates and how much it will really cost you over time.
Both ME’s Basic and Flexible Home Loans are available as interest only options.
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.