What is an interest only loan and why do property investors use them?

Low interest rates effectively make borrowing more affordable. With the Reserve Bank setting the cash rate at a record low, the flow-on effect to lending has been evident.

If a property investor is looking to maximise cash flow, one strategy is to pay only the interest portion of the property’s loan (and not repay the capital).

But this raises the question, what happens to the interest-only loans when rates fluctuate? The answer is business as usual, but first, what is an interest only loan and why do investors use them?

What is an interest only loan on an investment property?

Where an interest only loan used to purchase an investment property, the loan repayments only cover the interest, not the principal. In other words, the loan amount (principal) to purchase the property remains unpaid.

Reasons investors use interest only loans

Principal repayments are a substantial non-deductible cost of owning an investment property. Some choose to delay principal payments to assist their cash flow earlier on in their investment property journey.

Lowering the costs early on by delaying principal repayments provide investors with more cash than they would’ve had. This allows them to reinvest cash flow to assist them in achieving a stronger financial position when the time comes to begin principal repayments.

It’s common for interest only loans to have a higher interest rate compared to interest and principal loans. This must be considered when deciding on a loan, but a result of this is the increased tax deductions.

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