When you are looking to invest in the property market, there are so many options to consider - and not just what sort of property to buy and where.
There is also the issue of your home loan. When shopping around for the best product, you will be looking for a home loan with the lowest fees and most favourable interest rates, but you might ask yourself: 'Interest only or principal and interest?'
Principal and interest loan repayments
Traditionally, home owners have become accustomed to the principal plus interest mortgage repayment option for their loan because it is the preferred / easiest way to pay off your home loan and own your property outright as it is simply a set and forget option and the repayments do the work for you. With every repayment, the principal amount reduces whilst hopefully the value of your property increases thus providing you with additional equity in your home, giving you the potential flexibility to use that equity to either refinance or perhaps even buy another property.
As you continue to make repayments over the life of the loan, your interest costs will also reduce as you’re paying off the principle.
You can see the difference between the remaining principal based on either a P&I or Interest Only repayment arrangement.
Principal and interest repayment options are often chosen by owner occupiers.
Not sure what equity is? Take a look at our article ‘What is equity and how can you use it?’
Interest only loan repayments
But for the investor or home owner looking to reduce their home loan repayments, there is another option.
Interest only home loan repayments might be a good choice for a relatively short term loan like when investors are ‘flipping’ properties where the effect on cash flow is more important than reducing the loan. Choosing the interest-only option, however, gives you greater flexibility as an investor.
'Interest only' is usually only offered for a certain timeframe, ie a number of years and is dependent on the lender’s product offering and the borrower’s situation. You only pay the interest on your loan each month, which significantly reduces the amount you need to pay. For example, on an $800,000 home loan there is a saving of $1,207 per month by selecting interest only repayments based on an interest rate of 3.74%. Our home loan calculators can help you work out your own repayments.
Keep your investment cash flow high
But the lower repayments are not the only benefit. Interest only loans give you the choice to reduce your expenses to the absolute minimum, or make additional payments when you want to via an offset account. These additional payments might not just be to pay off the principal amount; they could be paid into a loan offset account so that you can further reduce your monthly interest payments whilst putting aside an easily-accessible pool of funds. As an investor who may be interested in buying more property or renovating your existing properties, this can be a wise choice particularly for those with variable income streams like bonuses.
Interest only for first home buyers too
Interest only loans might also be a good idea for an investor who plans to hang onto a property for a fairly short amount of time before selling it again, ensuring that during that time, cash flow is as high as possible. But this repayment option can also work for first home buyers who might be planning to live in a property for a while before moving on but keeping the first home as an investment. Interest only options for first home buyers provides an easier entry point.