Finance advice
Paul Wilson

How to use interest-only loans to your advantage

By Paul Wilson

If you want your portfolio to cost you as little as possible for the maximum reward, then you need to know how to use interest-only loans to their full potential. 

Blogger: Paul Wilson, Educating Property Investors, We Find Houses and We Find Finance

One of the first decisions you’ll have to make as an investor is whether to structure your loan as principal and interest or interest-only.

Various loan structures will suit one investment type or strategy over another, so it’s important to know exactly what you want to achieve from the property before you apply for the loan.

I’m going to delve deeper than the known pitfalls and benefits of interest-only loans, but before I do, these are the basics:

Pitfalls
• You won’t actually be building any equity through your repayments because you’re only paying interest, and not the balance on your loan. (Note: only a problem if you have purchased in a non-capital growth location and if you’re not servicing bad debt).
• A chain reaction follows on from the first pitfall and defeats the purpose of effective and successful investing: by not building equity you can’t leverage into another property.
• You may suffer financial hardship if you can’t manage the repayments after the interest-only period ends.

Benefits
• Allows first-home buyers to get into the property market sooner than they would be able to on a principal and interest loan.
• Enables investors to service a higher level of good debt due to them only being required to service the interest. If their serviceability allows, this will enable them to leverage into more investments.
• Smaller repayments in the short-term: this means freeing up cash to fast track the reduction of bad debt, and if you don’t have bad debt, this allows you to target the reduction of one of your investment loans, or enables you to leverage into more investment opportunities.
• Interest payments on investment properties are fully tax deductable, however any principal repayments are not.

The biggest pitfall of all
The biggest pitfall of interest-only loans doesn’t actually have anything to do with the loan itself – it’s you, the investor.

Taking out an interest-only loan and not using it to its full potential is one of the biggest mistakes you can make.

If you take out an interest-only loan but don’t have a good understanding of the full leverage capabilities, you might as well take out a principal and interest loan.

I’ll get to the strategy around interest-only loans in a minute, but first, there’s something you need to know.

What the banks aren’t telling you 
When a bank is looking at your serviceability for a loan, they factor in rate rises of one and a half to two per cent. So at the time of applying for your loan the interest rate may be two percent, but they will determine your serviceability at four per cent. 

This buffer allows for a huge amount of incremental rise before their lending reaches a dangerous debt service ratio – for them, of course. 

The RBA’s latest commentary on ‘households swimming in more debt than they can handle’ are, in my opinion, throwaway comments that do nothing more than scaremonger the average Joe who might have been considering investing until they read that. 

The thing is, bankers aren’t paid to educate investors and the marketplace. And there’s a good reason why. 

Could you imagine how many billions of dollars the banks would lose if their employees went around telling borrowers how they could use interest-only loans to their (the borrower’s) advantage? 

Re-education of the services and products provided by banks is needed, and it’s only people like us (independent buyer’s agents and exceptional mortgage brokers) who take the time to make sure you really understand this point. Yes, the banks might discuss it with you if you raise it with them, but the problem these days is that most advice is passive, i.e. ‘you ask me the question and I might give you the answer’. I prefer to share raw information with my clients so they are empowered to make informed decisions and to ensure they are always asking the right questions.

Using it to your advantage
Don’t just accept the banks’ business model for what it is. If you happily repay your mortgage at a rate they’ve dictated as ‘your serviceability’, you’re going to be disadvantaged from the get-go (which is exactly how they like it). 

Instead, abandon what the banks have drilled into you and consider this: obtain an interest-only loan and use it to your advantage. If an interest only loan is producing positive cash-flow, why not divert the excess funds off of your bad debt to eliminate the debts that have no financial efficiencies attached to them. 

Please make sure you speak to your accountant to ensure that this is in line with what will benefit you financially and also from a tax perspective.

I must note that this tactic will only work for investors who have strong financial discipline.

Those who currently have investment properties on interest-only loans are enjoying record-low interest rates, which means there’s definitely some left over cash. 

Obtaining the interest-only loan provides you with the flexibility to use your extra cash to pay down your remaining principle, fast track your debt reduction, and eventually leverage into higher value assets. 

Provided your investment property is located in an area with good prospects of capital growth, is currently being rented and you don’t have any major bad debt, you’re in a fantastic position to use the interest-only loan structure to your advantage.

The whole purpose of investing is to hold an asset for the least amount of expense in order to achieve the maximum amount of reward, and that’s exactly what interest-only loans (when used effectively) provide. 

Sidenote: borrowers who are not disciplined with spending and saving may find that an interest-only loan creates more problems than solutions, as it frees up extra cash, but also halts your mortgage principal at a standstill for several years.

This post originally appeared on www.wefindhouses.com.au

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About the Blogger

Paul Wilson

Paul Wilson

Paul Wilson is an Independent Property Investing Expert who's been educating and coaching investors since 2001. Author of 7 Deadly Mistakes Property Investors Make and How to Avoid Them, he also manages www.educatingpropertyinvestors.com.au, www.wefindhouses.com.au, and www.wefindfinance.com.au

Through his books and websites, Paul provides valuable, independent guidance and support by teaching strategies on how you can invest successfully, while protecting yourself from the common mistakes that trap many investors from reaching their full potential.

Paul doesn’t promote cookie cutter strategies, instead he demonstrates how you can create wealth as a property investor regardless of your budget, location, strategy and risk profile. Paul makes his home on the Gold Coast and spends his leisure time enjoying adventures, surf and sun with his wife and five children. Protect and grow your portfolio with knowledge. Contact Paul today for a complimentary consultation: 1800 690 890 and ask for Paul, or email [email protected]

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Will Magee has had ambitions to enter into the Australian property market for quite some time, but it has been more than just finances holding him back.  Having been granted permanent residency just two weeks ago, Will is wasting no time and is now in the process of signing papers and finding his first investment property.

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In this episode of the Smart Property Investment Show, Will joins host Phil Tarrant to share why he is purchasing his first property in partnership with his brother, discuss the complications that can arise from such a strategy, and unpack the ongoing plan for building a joint property portfolio with his brother.

Will will also share how they approached saving for their first property, why he is taking out the mortgage in his name exclusively, and share their savings plan for the year ahead.

If you like this episode, show your support by rating us or leaving a review on iTunes (The Smart Property Investment Show) and by following Smart Property Investment on social media: FacebookTwitter and LinkedIn.

If you have any questions about what you heard today, any topics of interest you have in mind, or if you’d like to lend your voice to the show, email [email protected] for more insights!

RELATED AREAS OF INTEREST:

From property in Australia to a ski lodge in Japan
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Should a real estate title be in one person’s name only?

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A property investment plan years in the making
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Median house prices in regional Victoria outperformed that of Melbourne in the June quarter, the latest REIV figures reveal. 

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Median house prices in the regions rose 4.0 per cent to $419,500 but in Melbourne they dipped by 0.6 of a percentage point to $840,000.

The result in Melbourne was due to a 0.8 of a percentage point fall in prices achieved at auction; this was despite a lift of 2.3 per cent in private sales.

Inner Melbourne suffered due to auction prices, where median prices fell by 4.9 per cent to $1,459,000 but it was middle Melbourne that was hardest hit, with a 5.4 per cent drop to $974,500.

Outer Melbourne had a good quarter with the median rising by 0.5 of a percentage point to $681,000.

Apartment prices in regional Victoria grew by 3.7 per cent to $304,500 while the metro media was up by 0.5 of a percentage point to $604,000.

REIV President Richard Simpson said that despite fewer sales, many sectors of the market were performing well.

“2017 was a bumper year and while the trendline has flattened, despite the fall in median house prices in the June quarter, median prices are still up this calendar year for both houses and units, in Melbourne and in the regions,” Mr Simpson said. 

In particular there was been strong growth in regional centres which is probably due to the first-home buyers’ concessions said Mr Simpsons.

“The first-home buyers’ concession has been a boon for regional areas. A new entrant to the property market buying a house at the regional median will pay no stamp duty, while a first home buyer of an apartment in Melbourne at the median price would pay stamp duty of nearly $25,000,” he said.

Mr Simpson said that more prospective buyers are looking towards regional Victoria which is also having an effect in Melbourne.

“Melbourne’s outer perimeter continues to grow. Small increases in the June quarter mean that the median prices for both houses and units have risen over 10.5 per cent from a year ago.

Mr Simpson said moving forward that vendors need more realistic expectations as the highs of 2017 are now over.

“Negative chatter about the future of the sector coupled with stronger lending controls by financial institutions has created some uncertainty and vendors need to be realistic with their price expectations,” Mr Simpson said.

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Regional Victoria showing up Melbourne in price performance, new data finds
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If Mark Hodge’s face looks familiar to you it could be because of his time working as a professional entertainer which saw him working with the Australian ballet, appearing on multiple seasons of Dancing with the Stars and touring in musical theatre for 17 years. What you may not know is that Mark is also heavily involved in the short-term property rental marketspace.

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Mark joins host Phil Tarrant to discuss his transition from entertainer to investor, a journey pushed forward by dance related injuries and even a hit and run which saw him needing to find alternate methods to bring in an income. Mark shares how bad long-term tenants and a gang member guided him to the short-term rental market, and how this pushed him into helping others to realise the same benefits.

Mark will also address the common concerns, discuss what his company Maisonnets specialise in and unpack how they are making the process of filling short term rentals easier for investors.

If you like this episode, show your support by rating us or leaving a review on iTunes (The Smart Property Investment Show) and by following Smart Property Investment on social media: FacebookTwitter and LinkedIn.

If you have any questions about what you heard today, any topics of interest you have in mind, or if you’d like to lend your voice to the show, email [email protected] for more insights!

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AREAS MENTIONED:

Melbourne
Sydney
Rushcutters Bay
Maroubra
Potts Point

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From pirouettes to property investment

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