Principal and Interest Vs Interest Only Loans: Why and when should you pay more interest?
In this How To Session, we’re going to get technical and start to talk about the pros and cons of interest-only lending when it comes to investment properties.
Now, it’s really important to understand why you would go interest-only. Because we have seen recently that there is an extra margin the banks are now charging us for the luxury of being interest-only (IO) versus principal and interest (P&I)—so it’s actually meant that the margin between investment property and owner-occupied property is even higher.
Why would we want to pay the bank’s extra interest? Because it obviously comes out of our pocket.
Well, the simple reason for it is, “What is your ultimate long-term goal?”
If you’re looking to accumulate more property, then the reason you would pay IO is because you get more surplus cash flow. That surplus cash flow can then be used to buy the next investment property. So the reason you would do that is to say, “Okay, I want to grab an extra property and that’s going to be part of my passive income for life.”
If you were to pay P&I instead; that surplus is going to be restricted because you’ve got to pay that principal amount. And if it’s restricted, you simply can’t buy another property. So it’s important to understand the benefits of having interest-only—because there is going to be a cost associated with it—and that is the long-term game.
Make sure you’re playing that long-term game.
If you are in the later stages of your investment portfolio strategy, then it might be the time to retire that debt out. If you are looking to retire that debt out, you might be saying, “Okay, well I don’t need any more properties, so let me go principal and interest.”
You may also want to make sure that you’re staging this. Because if you switched all of your loans over to P&I; you may actually go from a positive surplus to a negative cash flow surplus every month. Which might get yourself into some financial stress. And you don’t want to do that. You want to stage the P&I switchovers so you’re retiring that debt comfortably, while also maintaining your standard living in your current lifestyle. So it’s absolutely critical. It does get reasonably technical—in terms of doing those cash flow models—and that’s why we do recommend you seek professional advice in this area.
A good mortgage broker will be able to tell you the advantages if you stay IO, and what that means for your borrowing power; versus switching to P&I, and what that’s going to mean for your regular repayments. Because when you get multiple properties with multiple loan splits—all of those numbers are obviously a little bit harder to calculate.
So go out and get some professional advice from a qualified mortgage broker and it will help you on your journey to success.
Thanks for watching.