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Investment properties - the interest only option

I’m buying my first investment rental property. I’ve heard from friends that it may be advantageous to make interest only repayments if the property is purely for investment. Is this true?

More recent convention indicates that many investors – and yes, it tends to be professional landlords – do take the interest only option. Their reasoning is that it reduces the cash outgoings as the monthly repayments are less. The obvious reason is that you’re not paying off some of the principal.

The strategy is, in a nutshell, you buy the property and minimise the monthly costs by using interest only. You can even fix the interest rate, maximise your tax deductions and, as the value of the property rises, the relative size of the debt shrinks.

For example, if you bought in an area where the average rise in price was 8% a year, worked out on a 10-year basis, then if you bought a $200,000-priced house, its value after nine years would be $400,000. The loan to value ratio (LVR) at the start would be $200,000 to $200,000 or one. After 10 years the LVR goes to $200,000 to $400,000 or a half.

The professional investors will borrow again after their property gains in capital value by showing the bank that the LVR on the first house has gone down. This gives a chance to buy another property if their income and cash flow supports the plan. By paying off the principal, you reduce your cash flow and your chances to get more property.

On the other hand, many people like the comfort of paying down the principal and that just might suit their psychological bent. However, by tax law you can only claim the interest component of your mortgage repayments when you’re a landlord, though I reckon heaps of Aussies make a mistake on their tax return with this one.

Before you become a landlord or property investor, do a lot of reading and even go to seminars, but don’t get sucked in by the product flogging that goes with these often hyped up events.

For advice you can trust book a complimentary first appointment with Switzer Financial Services today.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

 

Published on: Wednesday, December 16, 2009

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