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Making the Switch from Interest-Only to Principal & Interest Finance
Home owners and investors alike are presented with such a wide variety of loan facilities these days that it can seem hard to work out what’s best in the long run, particularly when you consider your future borrowing power. The battle between Interest Only (IO) and Principal & Interest (P&I) loans may swing in favour of P&I, but why?
In light of the recent Royal Commission and the implementation of strict regulations from the Australian Prudential Lending Authority (APRA), loans have been met with tougher terms, shorter loan periods and higher interest rates. Interest-only loans in particular have felt the full force of these changes, which have long been the preferred choice for investors to maximise borrowing power and tax deductibility. More recently, however, investors are keen on signing up for Principal & Interest loans that offer more competitive terms and the ability to reduce the loan principal, particularly as P & I loans for property investment will, in many cases, only result in a nominal increase in monthly repayments.
What’s out there?
Due to tougher regulations, most lenders now break down their rates based on purpose and repayment type. This results in four separate interest rate brackets – owner occupied P&I loans; owner occupied interest-only finance; investment P&I; and investment interest-only. Another consideration when looking at interest-only loans is that lenders also enforce stricter serviceability calculations for interest-only loans. This can result in a reduction of payment terms from 30 years to 25, or even as low as 20 years depending on how long the existing loan may have been on Interest-Only repayments; ultimately bringing about higher monthly payments and potentially lower borrowing power.
Investors are increasingly mindful that they cannot rely solely on capital growth to build equity, and refinancing to a P&I loan may hold the key for many to get the most out of their investments. An example of this is below:
Investor: A client with a loan about to expire on one of three investment properties. After being shown the competitive terms available in switching all three to P&I, the equity-building capabilities boost future borrowing power. For only an additional $10 per month, he is able to reduce the principle on a $400,000 loan. The difference in payments on his three loans when compared with P & I are outlined in the following table:
|Loan Amount||Lender||Interest Rate||Monthly Repayments||Difference|
|$400k||Previous Bank||IO @ 5.69%||$1897 p/m|
|New Bank||P&I @ 3.99%||$1907 p/m||Extra $10 p/m|
|$385k||Previous Bank||IO @ 4.75%||$1524 p/m|
|New Bank||P&I @ 3.83%||$1800 p/m||Extra $276 p/m|
|$375k||Previous Bank||IO @ 5.11%||$1597 p/m|
|New Bank||P&I @ 3.83%||$1754 p/m||Extra $157 p/m|
Before you dive in
Although attitudes towards borrowing for property investment are changing, many investors still understand debt can be useful for asset wealth accumulation. It is important to realise though that one should never take on debt purely on the basis of interest-only payments just because it is slightly easier to repay in the short term. The affordability of an investment should always be assessed with an accountant, and on the basis of P&I terms.
Get in touch with McKinley Plowman today for access to a team of financial advisors in Perth, property accountants and business accountants that can make the borrowing process simpler, and potentially more successful. www.mckinleyplowman.com.au
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