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It is important to be aware that if you have investment debt, you will be paying higher interest rates than for owner occupier debt. This used to be the case 15 – 20 years ago, where the differential between investment and owner occupied loans was greater than it is currently. In fact, it was around one per cent apart. In other words, you could obtain a home loan at five percent, and your investment loan would be six percent.
As lender competition increased and, adding to that, the proliferation of mortgage brokers, the tug of war for business grew. In attempting to grow market share, the differential in borrowing costs between investment loans and home loans reduced to the point that the cost was on par.
Only recently have lenders reverted back to an increased cost for investment loans, and for that matter, interest only loans, when compared to principal and interest loans.. This differential is around 10 to 50 basis points (depending on the particular lender). For example, 4.20% verses 4.40% isa difference of 20 basis points. . For a while now, my view has been that unless the property market beings to plateau, this gap could stretch back out to 100 basis points or 1 percentage point on your interest rate.
The governments regulatory platform to slow down investment borrowing in the attempt to cap investment lending growth at 10% has the following objectives –
• reduce the number of investment property buyers;
• increase the number of home buyers;
• negate property price growth in Sydney and Melbourne
Under regulatory pressure, lenders have increased the serviceability requirements to access investment and interest only loans. This means, if three months ago you could borrow $600,000 in the same situation, now you may only be able to borrow $500,000 with banks and mainstream lenders.
Below are some key considerations for determining whether to select an interest only repayment. You should always base your decision on your long-term Property Plan and mortgage strategy.
• Maximise your cash savings: Interest only repayments are lower than principle and interest repayments. This means that you have more surplus money in your pocket each month that you can place into your loan or an offset account. This means that you can build your cash savings buffer more rapidly. This can assist with risk management, for example, should you have any unexpected expenses or in the event of reduced income for a period. This can allow extra time to make decisions that suit you.
• Maximise tax deductions: If you have tax-deductible debt you can select interest only to focus all surplus cash flow towards reducing non-deductible debt.
• Enhanced flexibility in your repayments: Your minimum monthly commitment is less than if you selected principal and interest which can provide for greater flexibility.
• You still have the same ability to pay extra off your loan: Many consumers are not aware that with variable rate interest only loans, you are still able to pay down the principle of your loan, either directly into the loan account or via your offset.
• Optimise your ability to hold properties: For example, if you have a home that you hope to become an investment property in the future, you may choose to store your surplus cash into an offset account rather than into the loan directly. This can allow you to maximise the deductions when the home becomes an investment, and your savings can go towards reducing the debt on your future home.
• No forced additional repayments: Without being forced to make additional repayments you may spend the extra cash that otherwise would have been used towards reducing debt.
• Potential for higher principal and interest repayments once the interest only period ends:With lender policy tightening, it is becoming more difficult to extend interest only periods with the same lender. You may be able to refinance to another lender if an extension is not possible with the existing lender. Should you not be able to extend the interest only period or refinance, as the loan term has now reduced, your minimum monthly principal and interest commitment will be higher than if you had of selected principal and interest repayments from the start.
• Higher interest rate: You are now paying a premium for the privilege of the extra flexibility and tax deductions that you receive from the interest only approach.
There is no one size fits all approach to mortgage strategy or property planning decisions. In conjunction with your Strategic Mortgage Broker, you should determine the approach that is appropriate based on your goals, risk tolerance and financial situation.
Risk management and money management are key components of a successful mortgage strategy.
All the best along your Property Planning pathway,
Click here if you would like to discuss your mortgage strategy, risk management or money management
David Johnston is the founder of Property Planning Australia and the author of ‘How to succeed with property to create your ideal lifestyle’ and ‘Property for life – using property to plan your financial future’.