You may hear it quite a lot “If you are an investor, you should definitely choose interest only!”, but very few people understand why this is, which can make choosing this product a less suitable option than you think.
Firstly, and most importantly, interest only is NOT to be chosen so you can afford your repayments. You should always base your affordability on principal and interest repayments. This is because an interest only period has a time limit and many lenders don’t like to go beyond a certain interest only period as it essentially gives you a much shorter term to pay off your home loan.
To help clarify, there are pros and cons to opting for an interest only period, but it is important to take both into account before deciding.
Here are some of the benefits:
As an investor, you may want to free up your disposable cash to re-invest in other wealth accumulating assets. Perhaps you are looking to buy again soon and maybe the extra cash would be better utilized somewhere else in the short term.
Maybe you have other debts accumulating interest at a higher percentage that you would like to focus on repaying first.
Perhaps you are looking to renovate the property and the extra funds in the short term would help increase the value of your home which you are looking to sell and make profit on.
Maybe you are a first home buyer and feel it would be easier to start off with a smaller repayment to get used to the new liability.
An interest only loan generally presents tax benefits to investors. If the interest paid on the investment loan is a tax deduction the investor can claim, then paying interest only maximizes that deduction. Paying off the principal means that interest would be charged on a smaller amount, which reduces the dollar amount of the tax deduction, so keeping the loan as interest only will mean having the maximum possible tax benefit.
And now for the cons:
It is important to know that the longer you have your home loan the more interest you pay over time. Interest only periods don’t last forever!
Only repaying the interest can leave you overwhelmed and unprepared when the loan reverts to principal and interest repayments. This could mean some tough lifestyle changes that you hadn’t fully anticipated the impact of.
Paying off principal from the beginning means you pay less interest overall and when you have a large liability like a home loan this can make a significant difference.
To summarize, there are positives and negatives to both and with many different features on offer like ‘offset’ accounts and ‘redraw’ facilities, it helps to understand what product will best meet your needs. Our recommendation is to always seek professional advice when making any financial decision, make sure you understand what you are signing up for and ask questions if you are unsure; this way you can be satisfied that you are making the best decision for your individual circumstances, as a ‘one way fits all’ approach is just not realistic.