Tax Tip 25: Only Use Interest Only Loans To Acquire Investment Properties

Only Use Interest Only Loans To Acquire Investment Properties


Another ‘basic’ concept - which some people don’t get.


Where you have non deductible debt (such as a home loan, car loan etc) then you should only have interest only on investment property loans. If you have Principal and Interest loans you would diverting repayments from your home loan to the investment loan. The balance on the investment loan would be decreasing which would mean you are ending up with less deductions. At the time time your balance on the non deductible home loan would be going down at a slower rate which means you would be paying more interest.


So the aim should be to pay down an owner occupied loan before you make any extra repayments into an investment property loan.


However, where you have no non deductible debt it is still a good idea to only use IO loans on the investment properties. The only exception would be if you are a compulsive spender in which case it may then be better to pay off the loan rather than spending the money on things you don’t need.


There are many other advantages with interest only loans

1. Lower payments;
   
   
2. Not reducing tax deductions;
   
   
3. can still pay PI if and when you want;
   
   
4. Can make lump sum deposits into the loan if and when you want.
   

Storing excess cash in offsets attached will

1. save same amount of interest as if paid into loan;
   
   
2. allow a cash buffer build up;
   
   
3. can allow you to live off cash rather than redrawing from loans - quicker retirement;
   
   
4. Stretch you further with purchasing ability;
   
   
5. Allow for related party loan strategies
   
   
6. Indirectly make the interest on money used for private expenses deductible.
   

 

I am continually gobsmacked by the number of people who don't know such a basic tip. Including myself when I bought my first property - I only happened upon SS by chance between exchange and settlement and on that same day I had my loan changed from PI to IO.

It seems that this advice only reaches most people when they start looking for property investment info, which is usually well after they've bought their first home. Usually by then it's too late!

Will never forget when one of my friends said they refinanced their old PPOR loan back up to 80%, used the cash as deposit for their new PPOR, tried to claim on old PPOR (now IP) interest but ATO gave them a right old slap

 

Yes it is still worthwhile pointing out the obvious as to the newbies it is not obvious.

I have heard many stories of mortgage brokers, and a fair few accountants, telling people to borrow against their investments and use the funds for private expenses - and claim the interest. Many people that I advise don't want to believe me and use the Ostrict approach - head in the sand.

 

Obvious ... once someone's told you

There are too many sub-par brokers, accountants and advisors out there. Ironically they are the people in the best position to share this basic tip to first-time borrowers!

 

However the APRA changes now affect the servicing calcs and IO loans are now calculated at P&I and a margin applied to the rate. The days of no differential between IP and PPOR loans has changed a bit.

The concept of using IO loans however does preserve cashflow.

 

Rolf.. I can see a day very soon where we are like the UK where IO loans are prohibited by law. I suspect APRA have drawn a line in the sand and if they need to regulate then IO loans will be confined to history. There will be a huge number of people affceted by this for non-property reasons and its why they havent acted yet. I can also see future OTP commitments being treated very differently by lenders.

 

Heretic !!! You could be burned at the stake. You are talking like you joined the greens and could be sent to a home.

 

How does an IO loan work? You pay interest for X number of years and then when do you start paying principle? Isn't IO loans generally set at a higher interest rate?

I can't bear seeing my mortgage amount remain at the same number year after year.

 

This is an old thread. In the good old days you keep extending the term and the rates were the same with pi loans.

These days things are different and it might be worth considering pi loans in some cases

 

5 years later and I think interest only loans are worth considering from the get go for investment debt - you can always covert them into a PI loan later on but cannot easily convert a PI loan into an IO loan

 

And the loan limits, Nanny state prevented sound metrics and nature from taking it s course to enable a supply of affordable housing. I can rember knocking back loans the banks offered because I knew they would be impossible to repay.

 

And don’t forget the strategy of paying PI loans and borrowing to pay the principal component creating a surrogate IO loan