Property investors often choose to set the repayments for their investment loans to ‘interest only’ repayments. An interest only repayment means you pay only the interest due each month, but you aren’t paying down the loan balance.
By comparison, a principal and interest repayment is made up of a portion that covers the interest due and a portion that pays down the loan balance a bit with each payment made.
Most property investors understand that they are able to claim a tax benefit for the interest component on their investment loans. When you’re paying only the interest due, it’s also likely your repayments are lower than they would be if you were paying a principal and interest payment so it can be helpful for cash flow too.
While there are some advantages to choosing an interest only repayment option, there are also some disadvantages to take into account too.
The majority of lenders limit the length of time you can remain paying interest only repayments. In most cases, this is limited to five years. After five years the repayments will automatically switch to principal and interest payments.
If you’ve only been paying the interest component for the first five years of your investment property loan term, you now need to make increased principal payments to ensure your mortgage balance is paid off by the end of the term.
For example, if you had a 30-year loan term and paid interest only payments for the first five years, you now only have 25 years remaining on that term to pay off the outstanding debt. The result for many property investors is increased principal and interest repayments.
Many lenders charge different interest rates for investment loans than they offer for owner occupier mortgages. There are also differences in the interest rates available for mortgages set to interest only payments instead of principal and interest payments.
In many cases, an interest only investment loan may be charged at a much higher interest rate. If you’re keen to reduce the amount of interest you pay, it may be possible to find more competitive options by switching to principal and interest repayments.
While you’re making interest only repayments, you aren’t reducing your investment debt at all. If the capital value of your investment property hasn’t increased over that time or if the property value drops, there is a risk of entering into negative equity territory.
Before you apply for an interest only investment loan, take the time to speak with a qualified mortgage broker and be sure you understand how it could impact your investment goals.
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