Interest-only loans let investors prioritize tax deductions and cashflow while delaying principal repayment. Offset accounts reduce daily interest: a $300,000 loan with $50,000 offset means you pay interest only on $250,000. Cap lending with any one lender around $800,000 to avoid higher risk profiling near $1,000,000.
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Interest only is in your interest. So why do many property investors and many homeowners only take out interest only loans? Mainly because they don't plan to actually ever own the property. They just want to buy the right to use the property for its capital growth and and rental yield. Most people who buy an investment property already have a home loan or personal debt, I.e. a credit card, car loan, etc. In most cases it is in their interest for tax purposes to put every spare dollar into paying off that personal or non deductible debt and maximising their investment or deductible debt. This is especially the case when the individual is using negative gearing as part of their strategy. Their aim is to have the largest loan possible so they can claim the interest deductions against it. Investors who have a positively geared portfolio are more likely to consider the principal and interest loan for their investment. Mainly because the lower loan amount in general, the less interest they pay and the more positively geared the loan is. However, these people still usually only move to a P and I loan only after they paid off their home loan first. People who are buying a home that they consider just to be merely a stepping stone to their end, a dream home, often consider using an interest only loan against their home loan as well. The theory is why pay off the principal and lose out on the offset account benefits of having a principal and interest loan? So let me explain that a little bit more with a principal and interest loan. It's interesting to note over a 30 year loan term, it's not to year 20 usually that the principal component of the monthly repayment is actually more than the interest repayment. So for the first 20 years you're mainly paying off interest, just a little bit of principal each month. Now if you don't plan to be in the house for 20 years, you're paying off a little bit principal that could actually be in your pocket, or even better in your offset account. Now if you had an interest only loan against your home, and you're putting that little bit of extra amount into your offset account each month, week, fortnight, then really what you're doing is you're actually building up your offset account. Now this goes into how offset accounts really work. Offset accounts are savings accounts, they're not loan accounts. And what happens, they're mainly with the big four banks. A lot of banks offer offset accounts as well. But what happens is you've got your interest only loan and let's say it's a $300,000 loan and you have $50,000 in your offset account, this is your bonus, your savings, it gives your grandma, etc. What the bank does is it calculates daily the interest on your interest only loan, takes $300,000, minuses the $50,000 and calculates your interest on the $250,000 loan. Now for principal and interest loans with offset accounts, it's not really the same calculation. Often what happens is the lender assesses that you're saving a little bit of interest and therefore your loan term reduces. You're not getting a benefit from a cash flow perspective each month in your account. So that's why a lot of homeowners these days also use interest only home loans rather than principal and interest. They want that little bit of principal repayment to go into their pocket or their offset account. Interest only periods are usually just 5, 10 years. Some lenders require a whole new loan application at the end of five years to continue for another five years, while other lenders just require a phone call request. If you kept your account in good order, make sure you're with the right lender if you know your circumstances are going to change within the time frame and you and you'll no longer fit their policies. Letting interest rates be your only guide can guide you into treacherous waters. In the recent past, many unsuspecting buyers has entered into an agreement with a lender based on an attractive honeymoon rate, a basic loan, or just an attractive general interest rate. This has then inhibited them from purchasing again, or even worse still meant that they've had to sell a property before upgrading to a new home. But more on that later. Focusing on the right features of the loan product, not just the interest rate, must be your priority. Then you need to find a lender with those features. And then you need to check to see whether you and your circumstances fit the lender and whether they will accept your application. Then and only then should you factor in the interest rate. So let's look at lenders exposure as you begin to build up an investment portfolio. There's a lot to be said for spreading the risk amongst separate lenders. Normally I suggest using a professional package for a home purchase, which then allows the scope to tap into getting some equity out with an additional line of credit for instance. And remember all those bells and whistles. Then for future investment property purchases, you may be able to use your current lender and be under that professional package. No additional fees. It's all great. However, I'd urge you to consider capping your lending with any one lender to around about $800,000. Once you get to a million dollars in lending with any one lender they kind of start looking at you differently because they'll apply a different risk profile to you potentially making it harder for you to borrow with them in the future. Hence that's why I always think $800,000 is a good limit to go to with any one lender. It still gives you room for a few top ups should you choose to access some equity in the future. However at the $800,000 mark and remember the million dollar is just arbitrary. Different lenders have different tolerance but I just want to make sure that you're considered to be a mum and dad lender not a high risk kind of person. To the lender that you're lending with $800,000 leaves a little bit of room for some future top ups for existing loans in future years. Now while this might seem like a lot of unnecessary work, structuring your loans so they are flexible and separate will get you to where you want to be soon.
