Over the course of my property investing journey, I’ve always been a big supporter of only paying off interest.
For whatever reason, the thought of only ever paying interest and never reducing the principal component of your mortgage is something that a lot of people don’t seem to like or can’t quite get their heads around. While there is no right or wrong approach to your mortgage, you do need to understand what the downsides to an interest-only loan are and what type of people should be looking to use them.
Firstly, there are negatives to interest-only loans.
The main one is that you will be paying a higher rate of interest than you would if you paid down both principal and interest. They will likely only be slightly higher in the range of 0.5-1% – but it is a real consideration.
The other downside is that you are never going to pay off your home fully. You could theoretically hold the property for 20 years and at the end of it you would still owe the same amount that you do on day one.
So why would anyone ever take on a loan product that costs more and means you’ll never own your property outright?
It all comes down to what you’re hoping to achieve. The great thing about interest-only loans is that it means you are actually paying less out of your own pocket each week or each month. The more money you are holding onto the more you are going to be able to spend on properties in the future.
It will mean that you might find yourself with more serviceability and that will allow you to go out and buy another property. Then over time, you can do it again and your property portfolio will keep on expanding.
If you are using every cent you have to pay off your loan, you might have one property that you own outright, but you could be missing a heck of a lot of upside if your property portfolio was five times bigger because you kept on expanding.
The other great thing about interest-only loans is that the money you are spending is tax deductible. That means you can pay it down with pretax income which helps even more with your cash flow.
Another important factor to consider when building a portfolio in this style is that just because you aren’t paying off the principal doesn’t actually mean that you are not ever going to have the property paid off.
For example, if you purchased another one or two properties over time thanks to your increased cash flow, you can use the increase in equity from the second or third property to pay down the first property. The longer you hold onto the properties the bigger this equity is going to be. You might be able to sell one property to pay off the first two.
This is going to mean you end up with more wealth over the long run, even though you never paid down a cent for the majority of the time. The more properties you can control the better.
Interest-only loans are just another tool for investors. If used in the right way they are a powerful way to expand your property portfolio.
If you are interested in getting ahead in the property market, feel free to reach out to a Henderson buyer’s agent today for more information.
