Interest Only loans or Principal and Interest when buying your first home?
What I am referring to here is the repayment option you have on your home loan. I am a huge advocate for choosing interest only loans for both the loan on the home you live in as well as any investment loans you might have. The main reason for this is Choice. I want to be able to make the decision on whether I am going to make the minimum repayment, being the interest component to manage my cash flow, or, when appropriate, make principal reductions by making payments into the loan, but more wisely, into an offset account if I have surplus funds available.
Selecting an interest only loan on your own home can be a very smart choice when planning for the future. Let’s take the scenario of someone purchasing their first home to live in. Now we grow up believing the right thing to do is pay off the loan as quickly as we can. I’m certainly not against the idea of reducing debt, but let’s explore if we can be a bit smarter in the way we approach managing our debt on an owner occupied home.
Being the first purchase it is likely not to be the home you live in forever, and many of us would look at changing homes in the short to medium term. When the time comes to move on it would be great to have the option of keeping this first home as an investment if it suited your circumstances. If you had set up an interest only loan when you first purchased the property, it would be a benefit to you as you wouldn’t have eroded your tax deductible debt.
Let’s say when you purchased this home you took a loan for $300,000, and you decided to move out and convert the property to an investment in 3 years’ time. If the loan was interest only then after 3 years you would still owe $300,000. If the loan was principal and interest you may have reduced the debt down to $280,000, depending on the interest rate you had and your repayment cycle. So you can see that the principal and interest loan has eroded $20,000 worth of tax deductible debt.
If you took an interest only loan on this property, there is nothing stopping you building up money in an offset account while you are living there, which saves you interest on your loan, but doesn’t actually reduce your debt. By choosing this option you are able to save a deposit for the next purchase, get the benefit of the interest savings while living in the home and keep your tax deductible debt as high as possible for when the conversion to an investment property takes place.
Understanding this strategy and planning ahead will see you positioning yourself the best way you can for a great start into the property investing world. You might also be interested in “Optimising your property investment portfolio“.
Garry Harvey – The Property Guy