Adelaide mortgage broker Dom Cassisi provides an overview of the differences between an interest-only and principal and interest loan.

For starters, you need to have an idea of why loans have an interest rate.

Put simply, it’s how banks and lenders make a profit. An interest rate is essentially the fee they charge you for their help. You repay them for this help gradually as you also pay back the amount you borrowed.

A loan without interest would be a wasted-effort and risk for the lender.

In an effort to simplify the loan repayment process, some lenders have a provision for letting you pay off the interest rate first. Afterwards, you can start making payments on the principal – the actual amount you borrowed.

Sounds convenient, right?

Let’s get a deeper understanding.

Interest-only loans are most popular with property investors for two main reasons:

• The interest is tax-deductible
• You make lower payments while your asset gains in value

However, the truth is that interest-only loans can actually be quite dangerous.

They’re so appealing because they do make for far cheaper payments, at the outset.

But the catch is that you’re not earning any equity on your property for the time that you’re merely paying off the loan. And your payments will be much higher once you finish paying off the interest portion. You can’t gain equity without paying off the property principal.

Why is this a bad thing?

Well, what if your property value DOESN’T increase?

Paying off the interest before the principal only works in your favor if your property price increases over the amount of time that you make the interest payments.

In this ideal scenario, you would have gained equity without actually having to pay towards the principal. Win-win! That’s why skilled property investors can attempt this strategic maneuver.

But is this right for you?

Attempting to invest in property with an interest-only loan might not be such a great option for a first-timer. And if you’re simply seeking to purchase a home, don’t let the appeal of lower initial payments fool you. An interest-only loan can backfire if your property doesn’t do well in the market.

Taking this gamble could land you with an investment debt that cripples your chances of getting another loan in the future.

Basically, we recommend that you pay off the entire loan over time with a principal AND interest loan to get it over with faster.

But if you’re experienced, have a good handle on the market and are prepared to take a loss, then an interest-only loan could be your ticket to a successful investment.

Ultimately, you need to consider which makes more of a difference to you: the short-term benefits or the long-term expenses.

To be armed with the best information specific to your circumstances, make sure you speak to your accountant or financial planner and also your mortgage broker.

At Funding Options, we’d love to help you with your loan. Contact us to schedule an appointment.

– Dom Cassisi, Managing Director