It depends on your personal circumstances. There are pros and cons to each approach.
Repaying an interest-only loan
As the name suggests, if you take out an interest only loan, you only pay back the interest charged and not the principal amount of the loan. So you’re not actually paying off the property loan at all. Why would you do that?
Well, generally people who take out interest-only loans do so because the repayments are lower than principal plus interest loans. They pay the interest (they may receive a tax deduction for doing so) and any applicable bank fees and, if the property rises in value, they can build their equity without paying a cent off the principal loan amount.
The other reason why investors take out an interest only loan is because they can easily work out the amount they can claim as a tax deduction. This is because the whole payment is clearly identified as an interest payment. Whereas a principal plus interest loan has both tax-deductible and non-deductible parts to it, so it can be a bit more complex to work out the tax benefits.
For example, if you paid $360,000 for your investment property and it is worth $400,000 after five years, you will have $40,000 equity in the property.
But this can be a risky strategy. If the property falls in value you may end up owing more than the property is worth because the outstanding loan amount may exceed the value of the property.
Let’s say you owned a property worth $360,000, with a $300,000 interest only loan at 5.20% pa. Your repayments would be just $300 per week, compared with $412 per week if you had a standard 30-year principal and interest loan, where you need to repay a portion of the principal as well as interest and fees. This frees up a significant amount of money each week which can be directed into an offset account, which allows you to reduce your debt, therefore reducing your interest payments.
Repaying a principal and interest loan
With a standard principal and interest loan, after five years you would have shaved nearly $24,000 off the balance of your home loan, assuming the interest rate doesn’t change.
But, if you take a 5-year interest-only loan in a 30-year mortgage, after the first 5 years are up, the loan will revert to a regular principal plus interest loan. This means that you will have only 25 years to pay off the principal, which will raise the amount of your repayments.
You can use our home loan repayment calculator to work out your interest repayments.
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It’s important to consider your particular circumstances and read the relevant Product Disclosure Statement or Terms and Conditions before deciding what’s right for you. This information hasn’t taken your circumstances into account.
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