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When you’re looking to finance an investment, what kind of loan should you consider – principal and interest or interest-only?
Unless an investor has a lot of money on hand, loans are the main option to obtain property. With both principal and interest loans and interest-only loans available, what kind of loan should investors go with?
Speaking on a panel with fellow investors on The Smart Property Investment Show podcast from a property event in Melbourne, Steve Waters, director of Right Property Group said which loan you choose should depend on the personal context of the investor.
“I’m a fan of interest-only unless you’re perhaps taking equity out of your principle place of residence,” Mr Waters said.
“Then, I’d probably entertain the idea of keeping those repayments as principal and interest but certainly on your investment properties, I’m a fan of interest-only, it frees up cash flow for you.”
However, investor Will says interest-only loans work well for him and his wife.
“We have… an offset bucket bank account where we put the excess funds that we would have paid off in that offset bucket,” he said.
“So, say, for example you had a $100,000 loan for your home loan. Instead of paying an extra $20,000 in principal, we pay that $20,000 to [ourselves] and, you’re still then only paying interest on $80,000 dollars.
“Also, with your investment properties, we pay interest-only and that excess cash flow we then reinvest in our next property to grow the portfolio.”
Investor Ross agrees with Will, saying “interest-only is the way to go”.
“If you’re paying principal and interest, that might be okay if you’ve got one investment property… but if you’re going to build that portfolio you really need the cash flow.”
Phil Tarrant, director of Momentum Media, parent company of Smart Property Investment, said that deciding on what loan would work best is a question best answered by a mortgage broker.
“They’ll sit down and explain how it all works to you,” Mr Tarrant said.
“There’s an end goal and the end goal is that you want to own property in a portfolio and be debt free on it so, how do you get rid of the debt?
“You’ve either got to sell some properties to pay off the other stuff or you can start paying down the principal further on, but you’ve got to get to the point where you’ve got enough clout behind you, a sizeable enough portfolio, so you can realise that end number and then you’ve got to start thinking about paying down the debt.”
Interest is the amount of money charged by a lender or financial institution for a loan, which is calculated as the percentage of the principal amount paid over the loan term.
A principal is a term used in Australia that refers to a client or proprietor in contracts, as well as a licensed estate agent responsible for an agency’s legislative compliance activities.