Finance advice

What are interest-only property loans and how do they work?

By Reporter
Interest-only loans

Interest-only loans can enable property investors to minimise their mortgage repayments, redirect their cash to high-returning investments and take advantage of a booming property market — but they’re certainly not for everyone.

Investors have a lot of choices to make when they’re building their property portfolios — Where will they buy? Will they look in capital cities or regional areas? Will they purchase a house or a unit? Does the property need a renovation? Will the renovation need to be cosmetic or structural? Which is more important: cash flow or capital growth? 

These choices don’t come up just once. A property investor may decide to target an existing cash flow positive regional house with renovation and value-add potential for one purchase and finance the mortgage with one of the four major banks.

Their next purchase could be a brand-new inner-city unit that is slightly negatively geared but which offers massive capital growth potential. The loan could be from a completely different lender. 

One of the choices investors will have to make with each new purchase relates to the structure and type of loan they will take out. Should you get an interest-only home loan for your property investment purchase or should you take the principal and interest option? The answer will depend on your property investment strategy, how highly leveraged your portfolio is, how quickly you are purchasing assets and how well you handle your finances.

What is an interest-only home loan?
Interest-only loans are often touted as an effective finance mechanism for property investors. 

The loan is much like other types of mortgages — it is a debt instrument which is secured by your property — but the monthly repayments simply cover the interest part of the loan. In other words, you’re not paying off the ‘principal’ part of the loan. The portion of your investment property that the bank ‘owns’ thus doesn’t reduce. You aren’t increasing your ownership of the property (your ‘equity’) as you would with a principal and interest loan.

Research firm CANSTAR has noted that interest-only loans are common within fixed-rate facilities. This structure enables borrowers to calculate future interest repayments and stay on top of their finances. In addition, some investors split their loans and have an interest-only portion to trim down their repayments.

Why do investors choose interest-only loans?
Interest-only loans tend to have a more flexible repayment schedule. In addition, because you’re only paying the interest part of the loan, the monthly repayments are lower than they would be on a principal and interest loan, which frees up additional cash flow.

Interest-only loans can appeal to property investors because they enable you to manage and minimise your mortgage repayments, the idea being that your asset will grow in value over the life of the loan.

Interest-only loans are also used by investors looking to ‘flip’ properties. These investors purchase properties which are expected to climb significantly in value and only hold onto them for a few years. Given that they’re looking to capitalise on the property’s surge in value — perhaps further assisted by a renovation — and to on-sell it within a few years, these investors don’t need to pay down the principal part of the loan.

With the smaller loan repayments, investors using interest-only loans can redirect their funds to something with a high return or use the additional cash to invest at an accelerated rate.

Interest-only loans are often said to suit disciplined and cash-conscious property investors. These investors are best placed to take advantage of the opportunities that interest-only loans offer without overextending themselves or being frivolous with their additional funds.

Interest-only loans can also suit someone who is building or renovating their own home because the loan will give them access to more cash for their project and reduce their financial burdens.

Things you need to know before taking out an interest-only loan
These loans are not for everyone. Throughout the life of your interest-only loan, it’s important to remember that the principal on the property is not reduced. Therefore, you aren’t creating any equity by taking more ownership of your home. 

When the interest-only loan period is up, you still have to pay off the asset, and you’ll need to make sure you’re in a strong enough financial position to meet these obligations once the need arises.

By taking out a five-year interest-only loan, property investors are banking on the capital value of their asset increasing — so they will ‘create’ equity without having to part with the additional cash.

No investment is risk-free though, and if you’re financing your investments this way, it’s important to remember that there is the chance that your property won’t increase in value.

Interest-only loans are also generally considered a short-term solution or financial strategy. Investors don’t take out 30-year interest-only loans, with five years usually the maximum time period for these loan facilities.

Interest-only loans have also been the subject of increasing speculation and scrutiny by industry watchdogs and regulators recently.

In 2015, the Australian Securities and Investments Commission (ASIC) began reviewing lending practices and found that lenders who provided interest-only loans needed to lift their standards to meet consumer protection laws.

ASIC cautioned that in today’s low interest rate environment, borrowers needed to build in a buffer to their minimum repayments to account for any potential rate rises and increases in repayments — particularly if they had taken out an interest-only mortgage.

In addition, ASIC’s deputy chairman Peter Kell said anyone planning on taking out an interest-only loan needed to have a clear plan of action for when the interest-only period ended to ensure they can afford the new repayment regime — which may increase significantly.

ASIC also warned that due to the seemingly lower repayments at the beginning of the life of the loan, borrowers can easily be tempted to borrow more when taking out an interest-only loan, which may not be in their best interest.

With so much to consider, it’s generally advised that property investors don’t simply take out interest-only loans because of affordability constraints. The risk with doing this is that once the loan reverts to a standard principal and interest loan, the investor may not be able to afford the increased repayments.

Instead, interest-only loans are best used when they are accompanied by a sound property investment strategy and relevant and personalised tax and financial advice.

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  ["title"]=>
  string(51) "Boost for investors as app sets up off-site bidding"
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  string(55) "boost-for-investors-as-new-app-sets-up-off-site-bidding"
  ["introtext"]=>
  string(144) "

Property investors are now able to identify and bid on auctions remotely using a new live-streaming functionality launched by Gavl.

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Called “Request an Auction”, the new functionality enables users to watch and bid on any Sydney or Melbourne auction remotely.

Through Gavl, prospective buyers are now able to register to bid on their preferred auction. The platform will obtain permission from the listing agent and confirm within 48 hours.

Vendors can also request to have their auctions broadcast to a larger buyer audience.

Co-founder Joel Smith said that auctions streamed on Gavl attract 47 per cent more viewers than traditional ones.

He said that Request an Auction will be valuable for remote buyers.

“Buyers are able to have Gavl attend any auction they nominate, so they will never have to miss out on an opportunity due to logistical complications in physically attending the auction.

“Vendors, too, have the opportunity to directly book an auction with us, so they can open up their event to buyers all around the world. With more potential buyers, they’re giving their property the chance to receive more bids and maximise their sales result.”

Mr Smith said that prior to the Request an Auction app, buyers were limited to what they could achieve through the Gavl technology.

Gavl is a live-streaming and bidding platform for real estate auctions.

Mr Smith said that it has streamed more than 6,000 auctions, which have achieved 3.5 million views from 50 countries.

Gavl’s Request an Auction function is currently being offered in Melbourne and Sydney only.

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Boost for investors as app sets up off-site bidding
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Having to split her time between Hong Kong and her original base of Sydney has not slowed Julia Tita’s goal of building a high-performance Australian property portfolio. Instead the resulting alterations to her strategy have positively impacted her investing success.

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Having recently purchased her 6th property, Julia joins host Tim Neary to discuss her journey, share her ups and downs over the years, and reveal her thoughts on why some properties are better than others.

Julia also explains why she no longer makes a move without the help of a buyer’s agent, why working with a strong team of specialists is extremely important and discloses her long-term property ambitions.

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:

Eagleby
Charters Towers
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Sydney
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Bondi

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How a move to Hong Kong impacted Julia’s Australian property goals
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  ["title"]=>
  string(88) "‘Common’ referrer practice of being paid on both sides of the fence coming to an end"
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  string(246) "

The practice of property investment firms sharing undisclosed kickbacks among the supply chain involved in development sales will be outlawed in NSW on 1 July this year under the Real Estate Reform being handed down by regulators in NSW.

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Property commentator and valuer, Suburbanite’s Anna Porter, said the reform will address conflicts of interest.

She said they arise when a mortgage broker, accountant or financial planner receives part of the commission from the property firm, who receive their fees from the developer or seller.

“This puts the broker into a position by which they are being paid on both sides of the fence,” she said.

“Until now this has been a grey area and there was nothing stopping this practice.” 

Ms Porter said this has been a common practice in the industry.

"Some well-known mortgage broking firms openly admit to receiving $5,000–$10,000 per referral in their pocket.”

She also said this process has been going on for decades.

"Property investment firms commonly pass some of their commission on to the mortgage broker, accountant or financial planner as a reward to them for passing on the referral. This means that many brokers or financial service providers are making significant amounts of money just to refer on to a property firm, often totalling hundreds of thousands of dollars a year," Anna Porter said.

Ms Porter said the Property, Stock and Business Agents Amendment (Property Industry Reform) Bill 2017 will be in force from July this year, and will prohibit this practice unless the broker or referring partner also holds a real estate industry license.

"Under the new laws, if the broker takes a referral fee from the property firm, they will have to be a licensed real estate agent and also hold a corporation’s license,” she said. 

“Subsequently, every transaction that they receive a referral fee from, they will be putting their license up against the transaction and taking full liability for the conduct, practices and outcome of that transaction, even if they have little to do with the transaction; they are a party to it financially and therefore take as much risk as everyone else in the transaction.”

Mr Porter said where a referrer holds a real estate license, and receives a part of the sale commission, they may find themselves in breach of the ethical requirements under the act.

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‘Common’ referrer practice of being paid on both sides of the fence coming to an end

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