Good day. My name’s Ben Everingham and I’m the director here at Pumped on Property and in today’s video, I’m going to talk about, should you pay interest-only or principal and interest payments off your home loan.
Good day. My name’s Ben Everingham and I’m the director here at Pumped On Property and we’re a buyer’s agency that have helped our clients buy literally over 100 million dollars’ worth of investment property in Australia, mainly the Sydney and Brisbane markets. In today’s video, I’m going to talk about whether you should pay interest-only or principal and interest repayments off your home loans.
I just wanted to start by saying I’m not a financial planner. I’m not a mortgage broker and this is definitely not advice directly related to your situation. If you would like advice related to your situation, please go talk to your mortgage broker, your financial adviser or your accountant but these are just some ideas and some of the positives and negatives associated with going interest-only or principal and interest and some of my own thoughts on the market place and what I’m doing personally right now.
There was a time when I was investing in property where all I did was pay interest only off my loans and that was because interest-only loans and principal and interest loans basically had the same interest rate. It was a no-brainer for me, during my accumulation phase of my portfolio, to basically buy properties, go interest-only which meant my holding costs were as low as possible, continue to save as much as I could and then reinvest in another property, go interest-only, use those savings from not paying principal to reinvest in another property and buy again.
That made sense for me because at that time, I was accumulating and because the difference between interest-only and principal and interest was relatively the same but things have changed recently at the time of recording this in 2017. In some instances with some banks in Australia, again, depending on your deposits and your overall financial position, interest rates can be as much as 1% higher for going interest-only right now as opposed to principal and interest and this is the reason I’ve recorded this video.
An interest-only loan is basically one where you just pay the bank back the cost of lending the money. Let’s say you buy a $400,000 property and you’ve got a $400,000 loan. Let’s say the interest rate was 5% on that property interest-only. You’d effectively be paying 5% of 400,000, so $20,000 per year in interest. Now, principal and interest-only loan is one where you pay your $20,000 in interest in year one effectively but then each week, you pay a little bit off the principal so that over a 30-year period, for example, you own that property completely outright.
What paying principal and interest does to your loan is it increase your out-of-pocket weekly cost as much, up to as much as 25% more than your interest-only repayments. At different stages of your investment journey, you’re going to want to be accumulating at other stages. You’re going to be wanting to consolidate and repay debt and there’s a time and a place for all different types of loans. Again, for your situation, go and talk to those advisors in your circle.
Some of the positives in the past for me with interest-only loans was obviously, you had more money to invest and it reduced your overheads, therefore, you could continue to save more money. It didn’t put as much of a strain. For example, a 5% rental return on a property where you would put down a 20% deposit on that property might have been after the cost of the interest plus the cost of holding the property with a 5% interest rate being a break-even property for some people depending on the markets where if you’re paying principal and interest, obviously, you’re losing money on a week-to-week basis definitely before tax if you’re in that same situation.
The benefit of reducing your overheads means that it’s not impacting your lifestyle in a way or forcing you to continue to work in the same way. It’s also allowing you to continue to reinvest money into other assets until you get to that point where you’re financially independent. Another benefit is it definitely improves the cash flow position on a property as I sort of just discussed. One of the negatives for me from interest-only, because I personally do pay principal and interest on all of my loans now and I’ll tell you the two reasons for that as we get to me sharing my own story later on in today’s video, but you’re not actually paying down the debt on the property or the principal on the property which means your debt position remains the same. If your plan is to hold the properties long, long, long term, there can be pros and cons to that.
For me personally, I like to buy property, sell property to repay big chunks of debt where other people have different strategies as I’ve explained in some of my other videos. Another negative is right now in today’s environment, and again, you might be listening to this in another time like it was two years ago where the cost of interest-only and the cost of principal and interest were the same but right now, the cost of interest-only can be up to a percent higher so you might be paying a lot more money just to hold that same property. There’s a business case that go, “Well, if I can save another deposit by not paying principal on the property or a number of properties and I’m going to reinvest that money and make something from it, it can make sense.”
In other cases like for me, for example, where I’m not really buying much more property at the moment because I’ve accumulated enough properties to achieve what I wanted to achieve, across a couple of million dollars’ worth of property at 1% higher interest rate, you can be talking about tens of thousands of dollars a year in extra repayments for no reason. If paying interest and principal, you’re in a financial position where you can do that, it obviously makes sense to save that money if you’re not planning on using that money for a better use and if it’s not going to cut into your lifestyle too much. That’s why I’ve really just recently readjusted my position across my portfolio to go principal and interest because I was thinking, what’s the point of paying all of this extra money out for absolutely no reason but I was in a position where I was lucky enough to be able to do that. If it was a position three or four years ago, there’s no way I could have been able to do that.
In terms of principal and interest, I just wanted to explain some of the positives and negatives associated with that as a strategy as well. One of the things I love about paying principal and interest, and I’ll get to this more in my own situation in a moment, is it reduces your overall LVR and reduces your risk. At some point or another, you’re going to want to be financially independent and you’re going to want to do leverage yourself. I’ve got two children and one on the way at the time of recording this video and the last thing I want to do for my family is put them in a position where they’re over leveraged or we feel overextended at a time where I just really want to spend as much time as possible with my family.
The third positive associated with going principal and interest outside of reducing your LVR and reducing your risk is it’s kind of like a forced savings. Now, I know you can’t just knock on the bank’s door and say, “Hey, I pay this money off at all different times in the cycle. I want it back now,” but I kind of do look at it like for savings, like let’s say for example, 500 grand on this property and I’m paying principal and interest which means in year one, I pay $10,000 off the principal, a couple hundred dollars per week on top of the interest-only repayment, then it enables me to set myself up and be in a position where I’m kind of forcing that $10,000 savings which if I ever need to access it in the future, I can go knock on the bank’s door. As long as I make that servicing criteria and it’s a time in the market where they will lend money to investors, I can get it back out and if not, it just sort of sits there and reduces my position on the property anyway which most of the time I’m happy enough doing.
A strategy that I’ve personally used is to obviously park money in offset accounts but that’s another conversation for another video. Some of the negatives is it reduces your ability to save money as I mentioned before as it increases obviously your cost base on every property and it makes each property definitely pre-tax negatively here or most of the time depending on your LVR and position. It can mean that you don’t get to save as much money or it can start cutting into your lifestyle and obviously, the cost can be up to 25 or 30% higher as well on holding that property from a interest/principal and interest perspective.
Again, you’ve really got to decide if you’re in a financial position to go interest-only because I know a lot of investors that never pay a cent off interest on their entire portfolio over their entire lifetime and then it’s only when they get to that point of starting to sell their own properties that they’ll use the cash from that to just wipe it out. As a business case for that as well, like obviously a lot of economists say, the value today of money is at the highest for repaying debt that it’s ever going to be and in 30 years from today, $400,000 in real terms might be the equivalent of a million dollars in the futures money and so there’s this business case of delaying the payment of principal and just sort of paying it off with futures money which is generally going to be higher than today with inflation.
There some of the positives and negatives associated with buying or going interest-only versus principal and interest. In terms of my position now, like I kind of alluded to before, there’s two major reasons I go principal and interest. The first one is because I hate debt as bad as this sounds and I don’t like being over leveraged. I don’t feel comfortable with it. I’m probably one of the lowest risk investors in Australia still buying property and we generally work with people that come from that lower risk perspective that aren’t trying to break the bank in one year but trying to do some meaningful work over a longer term period of time in terms of achieving financial independence but I don’t like that risk and so the fact that I’m paying down the principal makes me feel good, makes me sleep better and I know that I might not notice it massively today or I might notice it a little bit but it means a couple less coffees a week, a couple of less meals out with friends, maybe one less shirt per weekend, all of a sudden, the principal’s covered. I know over time in 15 years from today, I’ll have paid half of the property, often not even really noticed it.
The other reason I personally like it at the moment is as I said before, I might be able to get a 4% interest rate on a principal and interest loan but it might be 5% right now. When you extrapolate that over a number of properties over time, the difference in holding costs can be significant, 5, 10, 15, 50 grand a year by going interest-only versus principal and interest right now. For me, it’s more that cash saving today that I’ve gone for and it does mean that it puts a bit more of a burden on myself and my family but again, as I said I’m not really in a high accumulation phase anymore of my personal portfolio.
I’m happy to slightly modify my lifestyle now to make those savings and then once the marketplace readjust which it should at some point in the future, where interest-only and principal and interest lines for investors meet in the middle again, I’ll consider going back to interest-only and using the future value of my money to pay off the debt or to sell some properties down to it to pay off those chunks of debt which I like to do as well.
I hope you’ve got some value out of today’s video. I hope I didn’t ramble on too much. If anyone’s significantly interested in seriously considering this interest-only versus principal and interest, please reach out. Go to my website www.pumpedonproperty. You can send me questions through the contact section. You can provide a question in this video. We actually have just launched a business or about to launch a business called Loan Rocket, which I’m very excited about where myself and one of my clients will be helping people actually move into the mortgage brokering space which is new for Pumped on Property but that’s kind of maybe during the six months from today from actually being in the marketplace and being able to use that service.
I really, really, really appreciate your attention and time today and until next time, timing is everything. Thank you.