Investors use interest only home loans to reduce payment and maximise tax deductions
Most lenders offer interest only as an option for investors
A normal home loan is Principal and Interest ( P&I) ie: the Principal is the amount that you owe the bank and so with this type of loan you pay the monthly interest and some of the original loan amount and as a result gradually pay off the principal . However with an Interest Only home loan you only pay the interest each month while the amount that you owe ( the Principal) does not reduce. Interest Only loans are more commonly used by investors who want to reduce their repayments and maximise their tax deductions – these investors are using a “negative gearing” strategy hoping that they will make a profit from the capital gain ( increase in value) over a period of years.
Some lenders will allow owner occupiers to have an interest only loan and this can be very useful particularly if you can explain the tax benefits for example when you plan to rent out your home in the future. WARNING – If you plan to use interest only in order to simply reduce your repayments on your owner occupied home loan then you should possibly reconsider your plans and look for a more affordable property as an interest only loan will almost certainly cost you more in the long run.
The Prudential Regulators and ASIC have both clamped down on interest only lending in order to reduce the risk exposure to the banks and more responsible lending. As a result currently most interest only/investment property loans are more expensive and require more deposit.
Normally from 1 to 5 years interest only period
After the interest only period the loan will revert to Principal and Interest repayments although some lenders will allow you have another 5 year interest only period while some of the major banks will allow up to 15 years interest only. However most lenders will eventually insist on principal repayments and in these cases borrowers are often forced to look to refinance.
IMPORTANT If you intend to purchase an owner occupied property that may be rented out in the future you need professional advice from an experienced mortgage broker on how to correctly structure this loan – good advice could save you tens of thousands of dollars.
While an IO loan does not require you to repay any principal, it does not normally stop you from making additional repayments if you choose to.
The advantages of interest only home loans are:
- Your repayments during the IO period are lower – but this does not increase your borrowing capacity.
- You can normally make larger repayments which pays off part of your principal.
- You preserve a higher credit limit if ever you want to redraw money back up to your original borrowing limit.
- For investment loans on which the interest is tax deductible, an interest only option is often valuable as it gives you the option of maximising the size of your ongoing investment loan and the deductions you can claim. If you also have a home loan on which the interest is not deductible, the interest only investment loan can enable you to put all your spare cash into paying off the home loan. This increases the amount of money available for your next investment.
If you feel you need the discipline of principal and interest payments to make sure you pay off your loan, you may want to stick with a principal and interest loan – even if you can elect to have an interest only loan at no additional cost.
If you are concerned that the ‘interest only’ period might come to an end, you may want to get a ‘line of credit’. However unless you have specific reasons, be careful if you need to pay more for a line of credit. You can often get by with an interest only loan. And if the ‘interest only’ period ends, you can always tell your lender that if they don’t extend it, you’ll be off to visit their competitor (receiving another hefty cash rebate from Peach for the refinance).