[2/4] Interest only loan or principal & interest?

Should you go interest only or principal & interest when taking out a home loan? This is a question I get all the time. Let’s take a closer look.

What does interest only and principal & interest mean? 

Interest only is simple, you pay only the interest of the loan. Principal and interest means you pay the principal to pay down the loan balance. If you’re on interest only, you don’t pay down your mortgage, the balance stays the same. If you’re on principal and interest, you pay the interest charge and then a little bit more to bring the loan down. 

Investment properties and tax deductions

The first thing to remember is that your investment property is tax deductible, so the interest charge is deductible. If you have a mortgage on your own home, that original mortgage on your home is not tax deductible. If the mortgage on your home is a personal liability and not tax-deductible, then all of your investment properties should be on interest only until that first mortgage is gone. 

Why? Why would you pay down tax deductible debts if you have a non-tax deductible debt. All of your investment properties should be on interest only while your principal place of residence is on principal & interest.

Why this works with investment properties

If your investment properties are always receiving rent, then you can always afford to service the interest. As long as the bank will allow you to go with the interest only option, you should. If you can afford to put more money into your investment properties, that money is actually better spent on other properties since the real money-making in property investing comes from your capital growth.

So even if you can afford to spend more on your investment properties, sometimes it is better to keep them on interest only anyway and put all of that extra cash into a cash buffer – usually an offset account against your own mortgage. When that cash buffer exceeds the deposit for a new property, then go and get a new property.  

Disclaimer: Everyone’s circumstances differ so you’ll need to go see a broker or a bank or financial advisor to see what works best for you in your situation. 

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