When purchasing a property, the standard type of mortgage is to get a principal and interest loan. This means that you pay a lower interest rate but must pay a higher amount each month when compared to an interest only mortgage.
An interest only mortgage means that your principal never goes down and therefore you owe the same amount of money each year. So, why are interest only mortgages better for investment properties?
For a start, the monthly repayments for a loan of $400,000 would be approximately $400 less each month for an interest only loan as compared with a principal and interest loan.
Using the 3:1 earnings rule where one third of your income goes to tax, another third to living expenses and the last third to a mortgage, $400 would mean an increase of $1,200 earnings each month. This is a significant increase that a lot of people may not be able to afford.
But what if you could afford the extra $400 a month, why get an interest only loan then? Well, if you saved that $400 a month plus any extra money you could put aside, you could use that money to purchase another investment property instead of re-financing your current loan. This means that you have double the assets with greater growth potential.
Further, as your investment property value increases over time, so does the rental that you will be charging to tenants. That increase of income can be used to make voluntary payments towards your mortgage with no loss from your own personal income.
Lastly, as your investment property is viewed separately from your personal income you get from your work, you can create higher expenses than income from your investment. That is, you make a loss. This is called negative gearing and can be used to offset your personal tax. Thus, having a higher interest payment means a higher loss, which means a higher tax rebate.
Well, there are at least 3 great reasons to have an interest only loan when purchasing an investment property. Take a look at our other blogs for more tips for investing at https://investpartners.com.au/blog/