Interest-only loans: The pros and cons when you’re building your portfolio

The upsides

• They free up your cash

“The number one benefit of interest-only loans is that they preserve cash,” Mr Gupta said. This allows you to use the funds you might otherwise be pumping into the principal for the deposit on your next investment, which can be particularly helpful if you’re aggressively trying to build your portfolio. 

With interest-only loans, your repayments will remain very low, and while you’re not paying down the principal of your investment, you’re still making passive income, he noted.

• You can roll them over

You’ll only be able to take out an interest-only loan for a period of up to five years, but according to Mr Gupta, there are easy ways to extend that time frame.

If your borrowing capacity is the same as what it was at the end of your interest-only period, there’s no reason why your current lender shouldn’t offer to refinance with another interest-only period, he said. 

If they don’t? “You can just go to another bank. Someone else will give you an interest-only period,” Mr Gupta assured. “You can keep rolling this period over, building your portfolio and preserving your capital.”

• You make passive income

“If you’re buying a $300,000, $400,000 or $500,000 property and you’re going interest-only, you’re making maybe [between] two and 10 thousand dollars positive cash flow passive income that’s clear of all costs every single year,” Mr Gupta noted. 

That extra cash comes in handy in a number of ways. “You can use that to fund the next deposit, or you can go on a holiday. You can do what you want with it.” Mr Gupta said.

The downsides

• Interest-only rates are generally higher

“The difference between interest-only and principal and interest two years ago was about 0.25 per cent, but depending on the bank, it can be like 0.5 per cent now, sometimes higher,” Mr Gupta noted. 

“If you’re exclusively zoned in on the interest rate that you’re paying, then you should go principal and interest,” he said. But if your focus is on building your portfolio quickly rather than getting the best rate, according to Mr Gupta, interest-only still makes sense.

• You’re not paying off the loan

This one is perhaps the most obvious downside to interest-only loans – you never chip away at the debt. 

“But don’t fret, once you’ve built your portfolio, once you have that requisite number of properties, then you can switch over to principal and interest and start paying your loan down,” Mr Gupta said. 

“The whole idea is that in the building phase, in the acquisition phase of your property portfolio, interest-only is great.”

• They can impact your borrowing capacity

“If you’re [acquiring] your last property, you’re scraping another $300,000 to $400,000 in lending, you might consider going principal and interest because that might then open up you up for another $100,000 to $200,000 of lending,” Mr Gupta commented, noting that the banks will penalise you if you’re holding a collection of interest-only loans.