Pros and Cons of having Interest only Repayment on an investment property

20 Dec

For those who are planning to buy an investment property or already have an investment property, might be wondering if there are any benefits of having interest only repayment.

Let us take a real-life example.

John and his wife have been paying off the home loan for their owner-occupied property in which they have been living for the past 3 years and now they have decided to buy an investment property. Since they have been making some extra repayments to their home loan and the property price had risen as well, they were able to accumulate a fair amount of equity in the property.

The couple refinanced their property and used some of their savings to get the investment property with a 10% deposit.The couple chose for three-year interest only term. In the final year of their interest only period, John also began depositing $200 every fortnight into his offset account just in case they needed to access those funds.

By now, their owner-occupied property has also managed to accumulate more equity and the LVR has dropped to 70%. By refinancing this property and accessing the equity and using the amount they have saved up during their interest only period, the couple managed to purchase another investment property with a 10% deposit.

By being savvy with their spending and putting extra funds into their offset, the couple were able to start building their property portfolio through a low-risk interest only strategy.

Bad reasons for choosing interest only.

It is important to look at IO as part of a long-term investment strategy, not just a way of reducing your repayments in the short-term.

Where many borrowers get caught out is when their mortgage reverts to P&I repayments at the end of the interest only term and they will see a significant rise in the monthly repayments thereafter.

This is particularly true for an owner-occupied borrower because the less you pay off the principal amount, the more you end up paying in interest. For example, if you have a 30-year principal and interest home loan at 3.00%, you will pay a total of $207,100 in interest over the term of the loan. By contrast, if you have the same loan but start with a 5-year interest-only period, you will pay a total of $279,163 in interest.

So, what should you do?

The best way to make a decision here is to study your current situation and jot down your financial plan. Having your aims and goals in place and recognising your current financial situation will help you decide which option to choose. It is always good to consult an experienced mortgage broker/strategist who can guide you through.