If you're an investor in Redlands or greater Brisbane weighing up your next property purchase, one of the biggest decisions you'll need to make is how to structure your investment loan: interest only or principal and interest?
It's one of the most common questions I get asked as a mortgage broker, and it's also one of the most misunderstood.
The answer isn't about which one is "better." It's about which one matches what you're actually trying to achieve with the loan.
On an interest-only investment loan, your required repayments cover the interest charged on the loan during the interest-only period. You're generally not paying down the principal, so the loan balance remains largely unchanged unless you make additional repayments.
Interest-only periods are typically available for one to five years, depending on the lender and product. Once the interest-only period ends, the loan generally reverts to principal and interest unless another interest-only period is approved.
With a principal and interest loan, each repayment covers the interest charged as well as part of the principal. Over time, this reduces the loan balance. Your equity can therefore increase through loan repayments as well as any potential increase in the property's value.
The interest rate may differ depending on the lender and product, but the bigger difference between the two structures is how your repayments are allocated, your cash flow, and how your loan balance changes over time.
Let's use a simple example. Say you've got a $500,000 investment loan and, for illustration, we're using an indicative interest rate of 6.10% per annum.
These repayments are illustrative only and don't include fees or other loan costs. Actual repayments will vary depending on the lender, interest rate, loan term and loan structure.
For an investor, that $488 difference can be meaningful. Interest only can provide greater cash flow flexibility during the interest-only period. An investor might use that additional cash flow to help manage their existing portfolio, save for their next deposit, or maintain a larger cash buffer.
Principal and interest, on the other hand, means you're actively reducing the loan balance from day one.
So the decision isn't simply about which repayment is lower. It's about what you're trying to achieve with the property and the broader lending strategy.
Interest only can be attractive to investors who are actively building a portfolio and want to preserve cash flow during the interest-only period.
For example, an investor may prefer to keep their required repayments lower while they're saving for their next property purchase. It can also be relevant when an investor is managing a transition, such as purchasing another property before selling an existing home.
Some investors also consider directing surplus cash flow towards their owner-occupied home loan, where the tax treatment of the debt may differ from debt associated with an income-producing investment. The tax treatment depends on the individual's circumstances, so this is something to discuss with your accountant.
The important point is that interest only isn't necessarily about avoiding debt reduction. It can be about deciding where your available cash is most useful during a particular stage of your investment journey.
Principal and interest may suit investors who are focused on reducing their debt and building equity through loan repayments.
This can become particularly relevant when you're no longer focused on acquiring additional properties and instead want to progressively reduce the amount you owe. It can also be an important consideration if you're approaching a point where your income may reduce, such as retirement, and you want your debt to be lower over time.
For some investors, simply knowing that their loan balance is reducing with every repayment provides greater certainty.
Again, there isn't one structure that is automatically right for everyone. The important question is whether the structure fits your objectives and your broader financial position.
This is one of the biggest things investors can overlook when choosing between interest only and principal and interest.
A standard home loan is generally structured over a 30-year term. If you choose principal and interest, the lender may assess the loan with the principal being repaid across that 30-year period.
Interest only works differently. An interest-only period is typically available for one to five years, depending on the lender and the loan. Once that interest-only period ends, the loan generally needs to be repaid over the remaining term.
For example, if you take a 30-year loan with a five-year interest-only period, there are then only 25 years remaining for the principal to be repaid. That can make a significant difference when a lender assesses your borrowing capacity.
That means the assessed principal repayment can be higher. And importantly, lenders generally don't assess your borrowing capacity using the actual interest rate and repayment you're currently making. They apply their own serviceability calculations, which can include a higher assessment rate and assumptions about how the debt will be repaid.
So while a five-year interest-only period can give you lower required repayments today, it can also result in a higher assessed repayment when you're applying for your next loan. Depending on the lender's assessment methodology, that can mean lower borrowing capacity compared with the same debt structured as principal and interest.
This is why the structure of an existing investment loan matters when you're planning to buy another property. If you're building a portfolio, it's not enough to ask:
"What's the lowest repayment I can get today?"
You also need to consider:
"How will this loan be assessed when I come back to the bank for my next purchase?"
Another important consideration is that lenders don't all assess investment loans in exactly the same way.
They can have different policies around interest-only periods, loan terms, rental income, existing debts and serviceability. That means two lenders can look at the same borrower and the same investment loan and arrive at different borrowing capacities.
I see this play out regularly with clients across Cleveland, Victoria Point and Thornlands who refinance an existing investment loan and are surprised by how the lender's assessment of their existing debt affects their borrowing capacity for the next purchase.
It's not a reason to avoid interest-only lending. It's a reason to plan the structure around where you're heading, not just where you are right now.
There is no universal right answer between interest only and principal and interest. The right structure depends on your cash flow, how many properties you're planning to hold, your investment time horizon and how your overall lending position is likely to be assessed.
An interest-only loan can provide greater cash flow flexibility today, but it doesn't necessarily mean you'll have greater borrowing capacity for your next purchase. Likewise, principal and interest means higher required repayments today, but you're also reducing the loan balance over time.
That's why choosing an investment loan structure shouldn't just come down to the lowest repayment or the lowest interest rate. You need to consider how the structure fits into the bigger picture of your property portfolio and future borrowing plans.
If you're planning your next investment property, don't just look at today's repayment. Let's look at how the loan structure could affect your borrowing position for the next purchase.
If you'd like to understand how interest only and principal and interest could affect your cash flow and future borrowing position, you're welcome to get in touch to discuss your options.
Call me here or get in touch via the contact page . I work with investors across Redlands and greater Brisbane and I know this market well.
Lending on Coastal is a credit representative (576348) of Broker ACL Pty Ltd ACN 681 761 375 (Australian Credit Licence 563763).
Any reference to tax treatment of investment property costs or income is general in nature. Speak with your accountant for advice specific to your situation.
This content is general information only and does not constitute financial, legal, or tax advice. It has been prepared without taking into account your personal objectives, financial situation, or needs. Before acting on any information contained here, you should consider its appropriateness having regard to your circumstances and seek independent advice from a qualified financial adviser, mortgage broker, or accountant. Credit products are subject to lender approval and individual assessment criteria.
Figures and rate references in this post reflect general market practice at the time of writing and are subject to change as lender policies evolve. This post should be reviewed periodically to ensure ongoing accuracy.
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