What’s this ‘interest only’ loan stuff all about? Can it benefit you as an investor? The right loan structure could be your best friend!
When a property investor determines their long-term investment strategy and objectives, the loan structure is an important factor to consider as it can significantly impact the overall success of the investor’s portfolio. Seeking the advice of a financial professional will help identify which loan is right for the outlined objectives. Many investors might shy away from an interest only loan due to a fear that they will fail to chip away at the entire mortgage, however if used correctly, this option is highly beneficial for an investor’s cash flow.
Lower monthly commitments
An interest only (IO) loan requires the owner to only pay the interest charged on the loan each period, rather than making repayments towards both the principal and the interest. Using a home loan interest rate of 5% as an example, the monthly repayment on a $300,000 mortgage over 25 years would be approximately $1,754 per month for both principal and interest. However if you were making interest-only payments, the monthly cost would drop to approximately $1,250 per month. That means more money in your pocket each month.
Improve cash flow
Not only do interest only loans allow you to lower your overall periodic commitment, but payments you do make will help your cash flow and improve your ability to reinvest. By having a smaller financial commitment month to month, an investor has more flexibility to help pay for living expenses, boost savings and not feel bogged down by the mortgage. Or alternatively, property owners could look at putting this additional cash towards a loan that isn’t tax deductible – such as their home loan to help pay it off more quickly. Of course investors may also choose to use these funds to further build their investment portfolio.
Many investors look to sell assets throughout the journey of the loan in a bid to increase their overall equity and wealth, which is why two in three investor loans are interest only.
Any repayment that is made on the interest of a loan is tax deductible. However, payments on the principal are not tax deductible. This means that savvy investors can maximise the tax advantage through an interest only loan.
Many investors choose high appreciating properties so they can pay off the principal at the end of the term when selling the property, therefore increasing cash flow throughout ownership of the property.
Build an asset base
Interest only loans allow you to build a bigger asset base.
Take the following case study as an example. John and Sally bought in the inner city suburb of “Heavensville” in 1986. The average home loan in the 80’s was $75k and instead of trying to pay off the investment property loan, John and Sally chose an interest only loan.
With the extra $500 a month they had in their cash flow, they bought another investment property with a mortgage of $100k. Over the next decade Sally and John continued to buy investment properties every two to three years and again chose interest only loans with debts of $150k, $200k, $250k and $300k.
20 years after buying their first investment property in Heavensville they sold it for $1.5 million. John and Sally were able to not only pay off the debt, but were also able to pay off their owner occupied home loan and just about all of their investment property portfolio debt.
This example shows its not about how much money you earn, but how hard you can make your money work for you.