There are pros and cons to each approach. Whether you decide to pay the principal and interest or just the interest on your investment property loan will depend on your personal objectives and financial situation.
Principal and interest explained
A property loan has two parts:
- The principal - The amount you borrow to buy a property.
- The interest - What you’re charged by the lender for borrowing the principal.
For more information, check out our article on principal and interest and interest only home loans.
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. This means you’re not actually paying off the property loan at all.
So why might investors choose this option?
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 equity without paying a cent off the principal loan amount.
For example, if you paid $360,000 for your investment property and it is worth $400,000 after five years, you will have an additional $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.
Another reason why investors may take out an interest only loan is because the entire repayment can typically be claimed as a tax deduction. Whereas a principal plus interest loan has both tax-deductible and non-deductible parts, making it a bit more complex to work out the tax benefits.
Repaying a principal and interest loan
With a principal and interest loan, your repayments will initially be higher than they would be with an interest-only loan. However, you’ll own your property sooner.
For example, let’s say you owned a property worth $360,000, with a $300,000 loan at 5.20% pa.
If you had a standard 30-year principal and interest loan, where you needed to repay a portion of the principal as well as interest and fees, your repayments would be $411 per week. If you had an interest only loan, your repayments would be $299 per week.
While the repayments may be higher with a standard principal and interest loan, after five years you would have shaved over $33,000 off the balance of your home loan, assuming the interest rate doesn’t change.
Also worth noting, 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.
Need more help?
When you’re looking for a loan, ask your lender or a financial adviser to show you the difference paying each way can make over time, or use our rapid pay calculator to find out.
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This information is provided by AMP Life Limited. It is general information only and hasn’t taken your circumstances into account. It’s important to consider your particular circumstances before deciding what’s right for you. Although the information is from sources considered reliable, AMP does not guarantee that it is accurate or complete. You should not rely upon it and should seek qualified advice before making any financial decision. Except where liability under any statute cannot be excluded, AMP does not accept any liability (whether under contract, tort or otherwise) for any resulting loss or damage of the reader or any other person.