Interest Only Repayments on Owner Occupier loans
31 October 2016 MO'R Mortgage Options
If you choose to make Interest Only (I/O) repayments on your owner occupier home loan, you’re not actually paying down any of the principle loan amount. So, why would you choose them over Principle and Interest repayments, if it’s not going to help you own your home sooner?
If you’re using an offset account and building up the cash you’re saving, Interest Only repayments can provide great flexibility on your owner occupier home loan.
Here are a few situations when Interest Only repayments can be a good option.
1. You anticipate a period of reduced cash flow
I/O repayments are lower than P/I repayments. So if you’re expecting cash flow to be tight for a period of time, I/O repayments might help ease pressure over a specific time frame.
However, you need to make sure you’re actually saving the difference in a linked offset account. Otherwise, you’ll end up paying more interest over the long term.
2. There’s a chance your current home will become an investment property
If there’s a chance your existing home will become an investment property in the future, making I/O repayments now can provide benefits later on.
The answer is related to the concept of good debt and bad debt, with the aim to maximise the ‘good debt’ and minimise the ‘bad debt’.
Debt raised to pay for something that generates income – like an investment property – is generally considered ‘good debt’ because it has taxation benefits associated.
Non-deductible (or personal) debt is considered ‘bad debt.’ There are no taxation benefits with bad debt because it’s been used to pay for something that does not generate income, like an owner occupier home for example.
If you choose to make Interest Only repayments on your home loan now, you won’t actually pay off any of the loan. But this is not necessarily a bad thing when this property becomes a rental property later on because it means you are able to claim interest on a larger loan amount.
There’s a catch though.
This strategy only works if you’re saving the difference between what you pay in I/O repayments and would you would pay if you were making P/I repayments and putting it into an 100% linked offset account. If you use this cash as your deposit on a new owner occupier purchase, it will help you keep your new owner occupier loan (i.e. bad debt) as low as possible.
If you make I/O repayments on your owner occupier home but don’t follow through with the rest of the plan (i.e. building up your savings!), you will end up paying more interest and have higher debt levels over the long term.
What if I change my mind and don’t end up renting out my property?
If it turns out that your existing property doesn’t end up becoming an investment property after all, that’s ok because you’re no worse off.
Building up cash in a linked offset account has the same ‘interest saving effect’ as paying the funds directly into your loan, but you have the flexibility to use them for another purchase if you wish.
It’s important to remember you can make principle reductions to the loan at any time. It’s also generally easy to switch to P/I repayments if you try I/O repayments for a while but decide it’s not for you.
If you have any questions or would like to know more about this or other strategies you can incorporate within your existing, or proposed finances, feel free to contact us to discuss.