Deciding on the right loan structure as a property investor, is a little bit like choosing the right outfit on a first date. It depends on what stage of life you’re at!
If you’re new to the game, something a little daring might work best. Later on, you might want to play it safe.
It’s the same for property investment and the stage you’re at reflecting how risky or safe your loan structure needs to be.
Here we weigh up the pros and cons of principle and interest loans vs interest only loans for property investors.
UNDERSTANDING DIFFERENT TYPES OF DEBT
Any type of loan is a type of debt. Debt can make people nervous. If you want to be successful as a property investor it’s important you know the difference between good or rich debt, and bad or poor debt.
Poor or bad debt, is just that – BAD!
Bad debt is borrowing money from a lender to buy something that immediately loses value and has no prospect of earning you an income.
Bad debt is spent on things like new cars, jet skis, motorbikes, furniture. Expensive to buy, these items lose value as soon as you make the purchase. They never resell for more, or even the same, as what you paid, and it’s impossible to generate an income you can live on from them.
Rich debt is using other people’s money (usually the bank’s) to buy an asset. An asset puts money in your pocket. An investment property puts money in your pocket via rent. As an asset, an investment property has an added bonus in that it also benefits you with some tax effectiveness and efficiency that can also put money in your pocket. A jet ski doesn’t do that!
As a property investor you need to get comfortable with debt. There is nothing wrong with debt as long as it’s rich debt and not poor debt. You just need to know the difference.
WHEN INTEREST-ONLY LOANS ARE THE RIGHT CHOICE
During the acquisition phase of your property investor journey, your primary aim is to purchase the right properties, not to pay down your debt. Embracing debt can take a while to get used to, but you need to think about the long game and what you’re trying to achieve, i.e. many properties, all creating wealth.
If you can get an interest-only loan in your acquisition phase, this is 100% what you should do. Why?
Because interest-only loans give you flexibility with cash and that flexibility allow you to move on to the next property faster. Having access to spare cash is vital in your acquisition phase, which can last for years. If you’re paying every last cent you have to pay down your principle, where is the next deposit amount going to come from when you want to buy a second, third or fourth investment property?
If your comfort-zone demands some visible debt reduction – or at least the potential of it – instead of a principle and interest loan, opt for an offset account.
The advantage of an off-set account is that you can put any extra money into that offset and make extra payments if and when you want, but you retain access to that cash.
If you opt for a principle and interest loan and you suddenly need money, you have to apply to the bank to redraw that money – and there’s no guarantee they’ll say yes. An off-set account gives you the comfort of seeing some “savings” without losing control of the money.
WHEN A PRINCIPLE AND INTEREST LOAN MAKE SENSE
When you move from your acquisition phase, into your holding phase, and finally into your consolidation phase of property investment, it might be time to change your loan structure.
Unless you have a significant income, it’s hard to pay off debt while borrowing money to buy three or five investment properties. But once you’re happy with your portfolio, a principle and interest loan can help you start to pay down your debt, while still reaping the rewards from your investment incomes.
No matter what style of loan you choose, the most important thing is that you are able to service that loan while achieving your goals.
LOAN STRATEGY IS FUNDAMENTAL
Having a long-term plan around your loan strategy will be important to your overall success as an investor.
Let the experts at Positive Real Estate teach you about how to calculate your loan repayments while you’re still investing at one of our free property investing seminars.
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