27 Sep Q&A Wednesday: How do I know when to move from an interest only to a principle and interest loan?
This week we’ve got a question from Jason.
“When or how do you know to move from an interest only to a principal and interest (P&I) loan on your investment property? We have a great tenant but we’d like to start paying down the loan. There are 17 months left on a fixed rate, which is the issue.”
So we’re going to split up this question into two for you Jason!
What happens if you have a fixed rate, can you make extra repayments.
If you have a fixed rate you’re limited in how much extra you can make in repayments. For Jason’s bank, they’re limited up to $10k in extra repayments per year. He can start making repayments today but your bank could be different. If Jason goes over that $10k the bank will charge him fairly big break fees. So, yes you can make extra repayments and in your situation, it’s up to $10k.
What are the advantages of this? How do I know if it’s beneficial?
There’s now a difference between the interest rate you pay. On an interest-only loan, you’ll be paying a higher interest rate. It works out to be 0.45-0.6% so it’s a big sting. On principal and interest, you’ll be paying more as a total repayment however you’ll be paying far less in interest. It’s a bit of a balancing act where if you’re cash flow poor, interest only is better because you’re paying less but P&I is better if you’ve got additional cash flow.
It’s a bit of a balancing act where if you’re cash flow poor, interest only is better because you’re paying less but P&I is better if you’ve got additional cash flow. Yes, paying the principal isn’t deductible but its forced saving and you can utilise those funds.
Yes, paying the principal isn’t deductible but its forced saving and you can utilise those funds.
Some interesting research done by Macquarie Bank, they said by using a 0.5% difference, bank customers in the top tax bracket with a $500k investment loan would be $6k better off after 5 years and $12k after 10 years switching to P&I and that’s after taking into account negative gearing. Simply because by paying that extra half a percent has obviously cost you a lot more cash flow wise. If you’re in this situation jump online and do a calculation. If it’s only going to cost you a small amount extra per month its worth considered, even though it’s an investment property and even though that half a percent might be tax deductible, it’s still a cost to you.
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