It’s the age-old debate.
Should you structure your property finance as principal interest or interest only?
The reality is, there’s no one size-fits-all, especially when you’re a property investor and your needs are unlikely to be the same as a single-home owner.
In saying that, your finance set-up is critical to get right, and could make a major difference in your long-term ability to create wealth.
Here’s the basics to help get you started.
A Rookie Guide
Yes, it may sound simple, but there’s nothing wrong with reminding ourselves of exactly what the primary differences are between the two loan types.
Principle Interest – You’re paying your principle down, as well as interest, from your first repayment – meaning you could pay less interest over the life of the loan. Monthly repayments will be higher, but interest rates on this loan structure are usually slightly lower. Only the interest portion of the repayment is tax deductible.
Interest-Only – While your minimum monthly repayments will be lower, you could pay more interest over the life of the loan due to not reducing the principle amount. The entire amount you pay is tax deductible.
Getting Comfortable With Well-managed Debt
As you start to buy investment properties and build a portfolio, the stress of taking on more debt could start to weigh on you.
In your head, an interest-only loan could exacerbate these concerns because you know that you’re not reducing that principle debt sum.
However, it’s important to remember that you’re playing the long game here for greater future wealth, and some risk can be well calculated and managed.
As you buy properties and start to manage, maintain and possibly even renovate them, an interest-only loan could serve you better for a number of reasons.
Lower monthly repayments will give you access to more cash and financial freedom.
Another advantage – every dollar you pay against the loan is a tax deduction.
You can also put any available funds into an offset account, meaning if you need that cash it’s readily available to you, whether it be to pay down the loan once the interest-only period has ended, or for something else. With a principle interest loan, once you’ve made a payment, that money is now with the loan provider and to access it you will need to make an application to draw it back.
Pro’s and Con’s
A standout advantage to a principle interest loan is psychological – you feel better knowing that your debt is going down each and every time you make a repayment.
It’s also a fairly constant proposition. Unlike an interest-only loan where repayments are likely to significantly increase as the interest-only term comes to an end, your principle interest loan repayments are likely to stay very stable.
There’s also the comfort that should a crisis occur – you lose your job or the market significantly drops – you have much less debt because you’ve been paying down the principle amount.
However, while the risk-averse among us might like the idea of paying down our debt as quickly as possible, again we have to remember that property investment is about making educated risks and – that phrase again – playing the long game.
Principle interest loans make it much harder to access cash once you’ve made a repayment and don’t give you a tax deduction for the whole amount.
Different Strokes For Different Folks
When deciding on a loan structure, there is no right or wrong answer. There are many factors to consider based on your overall wealth creation strategy. To help you reverse-engineer a strong plan, talk to a property professional who has been there and can demonstrate success in this field.
Remember, you don’t have to do it alone. Starting out as a property investor can be a long and lonely road, filled with many mistakes and setbacks – but it doesn’t have to be that way. For a limited time, we’re running a free property investing seminar.
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Founder – Positive Real Estate