What is an interest-only investment loan?
A home loan repayment typically consists of two parts - the amount you borrow (the principal), and the interest that the lender charges based on the size of the loan. Typical home loans charge what’s called ‘P&I’ - or principal and interest.
With an interest only home loan, minimum repayments will only cover the interest charges on the loan for an agreed period of time while the principal remains unaffected. Therefore, the ultimate underlying balance won’t reduce during the interest-only period.
Interest rates for interest only home loans are usually higher higher than P&I home loans, but there are still a few benefits to choosing an interest-only loan for the first few years as an investor.
Interest-only investment loan rates & lenders
Buying an investment property or looking to refinance? The table below features interest-only home loans with some of the lowest interest rates on the market for investors.
Advantages of interest only investment loans
The main aim of the investment game is to purchase a property that will increase in value over time, and hopefully one day sell for a profit while gathering rental income in the meantime. This is called capital gains.
The idea with interest-only investment loans is that when an investor sells the property, they can use the money to pay off the principal while still making a profit.
Interest-only home loans can also enable investors to secure a property while minimising their repayments. This could be especially useful when trying to find tenants and to minimise other startup costs.
The other advantage is at tax time. During the interest only period, because you’re not paying off any of the principal on the property, the entire interest-only portion can be claimed as a deduction against your income. In some cases you can also choose to pay interest annually in advance, to help reduce your taxable income.
Disadvantages of interest only investment loans
It’s important to remember that while interest only payments are lower than if you were paying the principal component as well, the loan balance isn’t reducing.
At the end of an interest only period, the balance of the loan must be paid back to the bank over the period remaining before the end of the loan. This means that the principal and interest repayments will often be higher than prior to the interest only period.
Once you start paying both principal and interest, only the interest on your investment home loan can be claimed as a tax deduction.
There is also always a risk with interest-only loans that the property’s value doesn’t sufficiently increase. In this case you may end up with a large debt owing, and the principal on the home loan at sale time outweighs what you sold the property for. When combining that with other investment costs, body corporate fees, rates and more, the costs could start to add up.
In addition, interest only loans usually have higher interest rates compared to principal and interest loans. You will also pay more interest over the life of the loan as you aren’t reducing the loan during the interest only period.
Image by Max Bottinger via Unsplash
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