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Interest-Only Investment Loans

Looking to buy an investment property? Interest-only investment loans offer short term cash flow and tax benefits. We cover the pros, cons and what you need to know about interest-only loans.

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, updated on August 7th, 2023       

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Interest-only investment loans are a popular way to finance investment properties. Tax benefits and low payments are enticing but you can run into trouble at the end of the interest-only period.  We cover the benefits, pitfalls, crunch the numbers on repayments and see how they stack up against a standard loan.

What is an interest-only investment loan?

With an interest-only investment loan your repayments only cover the interest accrued on the amount you borrowed (principal) for a set period, usually 5 to 10 years.

You pay nothing off the principal during that time.

This means the amount you pay each month is significantly lower than a standard principal and interest loan repayment.

Once the interest-only period is up you have to repay the principal; either as a lump sum or by switching to increased principal and interest repayments.

Why property investors use interest-only loans

As an investor, an interest-only loan can be an attractive option for a few key reasons;

Tax benefits

You can claim a tax deduction on the interest, or portion of the interest, charged on a loan to buy an investment property.

This means you can make repayments on tax-deductible debt while using more of your income to pay off the mortgage for your owner-occupied property which isn’t tax-deductible.

Free up cash flow

Smaller repayments help maximise cash flow. Investors can channel more money towards other investments, renovations, general expenses or simply make repayments manageable.

How do repayments on a standard loan vs interest-only investment loan compare?

Using our loan calculator, let’s compare monthly payments on a standard loan (principal and interest) with an interest-only investment loan.

Loan type Amount borrowed Term Interest rate Monthly payment
Standard (principal and interest)
$200,000
20 years
5%
$1319.91 (full term)
Interest - only
$200,000
20 years (10 years interest-only)
5%
$833.33 (interest-only period)

What happens when the interest-only repayment period ends?

Once the interest-only period is up borrowers have 2 options;

  • Repay the lump sum in full: Pay the principal amount borrowed in a lump sum. Investors may choose to sell their investment property to finance this payment.
  • Increase your loan repayments: Make higher repayments that include interest and principal to repay the loan.

Staying with the $200,000 loan example above, let’s say the 10 year interest-only period of $833.33 monthly repayments has finished.

The $200,000 borrowed is still owed in full. New loan repayments will be calculated on repaying the principal and interest over 10 years – the remaining term of the loan.

The new monthly principal and interest repayment will be $2,121.31. A hefty increase of $1287.98 per month.

Can you afford higher repayments?

This jump in repayments is where some investors get into trouble.

It’s important to make realistic predictions about your future financial situation. Will you be able to afford higher repayments?

Use our home loan repayments calculator to work out the difference in repayments on any of the interest-only investment loans you’re considering. 

Crunching the numbers now can help reduce financial stress down the road.

Is an interest-only investment loan right for you?

An interest-only investment loan may be suitable for you if:

You can handle increased repayments

 You're confident your income will increase in the foreseeable future for higher payments or you’ll be able to cover the lump sum payment.

You’re expecting high levels of property appreciation

 The assumption that a property is going to significantly increase in value during the interest-only period is one of the main reasons investors take this type of loan.

The investment property is a fixer-upper

The investment property you’ve got your eye on needs fixing up. Smaller repayments mean you can channel cash towards renovations.

You want to invest in other wealth-building assets

Interest-only investment loans can free up cash to put towards other investments and diversify assets – like building a share portfolio.

What to consider when comparing interest-only investment loans

Here’s what to look at when comparing lender offers to find the best option for you.

What is the comparison rate?

When comparing loan products and interest, use the ‘comparison rate’ to understand the real cost of the loan.

This rate factors in most of a loan’s fees and charges while the ‘advertised rate’ is only the percentage of interest you’ll be charged.

How long is the interest-free term?

When will interest plus principal payments kick in and what will the new repayment be?

Is there an option to pay down the principal and redraw?

Some lenders will give you the option to pay down the principal with an offset account.

This gives you the flexibility to make extra repayments towards the  principal or withdraw from the account at any time.

What fees are associated with the loan?

Consider the cost of fees for the loan application, late payments,  account keeping, redraw, and any ongoing costs. These can add up over the term of the loan.

Compare total interest payable

It can be helpful to compare an interest only loan with a principal and interest loan too. This can show you how much more interest you may pay overall with an interest-only vs principal and interest loan.

We’ve made it easy to compare  loans  from Australia’s most trusted lenders with our loan comparison tool. All lenders who offer home loans offer interest-only loans. As such, the comparison tool shows the same home loan offers you would see on the standard page.

Pros and cons of interest-only investment loans

PROS

Smaller monthly repayments compared to a principal and interest loan.

Potential tax benefits. Interest repayments on loans for investment properties are tax- deductible. This applies to all investment property loans – including principal and interest loans.

You can use more of your income to pay down other debts, save, and invest.

Allows you to hold a property at the lowest cost while you wait for an increase in value.

CONS

If the investment property doesn’t increase in value during the interest-only period, you don’t build up any equity in the property by only paying interest.

You may struggle to afford the significantly higher repayments at the end of the interest-only term.

In the long run, you might pay more interest than you would on a principal and interest loan.

You don’t pay anything off the amount you owe, so it doesn’t reduce.

You might be tempted to borrow more than you can afford based on the smaller repayments.

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