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P&I vs Interest Only

To start it is worth understanding why many investors look to utilise interest only mortgages.
 
Firstly, it is recommended from a tax point of view as if you still have personal debt (i.e a mortgage on your personal residence) it makes sense to consider paying off personal debt prior to paying off investment debt as the personal debt is not normally tax deductible.
 
Secondly, you will hear often from speakers at property investment events that it is better to focus on going interest only and using the increased cash flow to purchase more properties than to focus on reducing principal. The argument in favour of this strategy is that you can gain more wealth from capital growth than you can from paying off principal. While this argument has some validity especially over the last couple of property cycles there are other considerations such as:
 
  • Often investor’s who are utilizing interest only loans so they can grow a larger portfolio, end up having to sell some property off as interest rates rise and they don’t have much cashflow flexibility. Note that if you pay principal and interest then you have the flexibility to go interest only thus freeing up cashflow.
  • Note that often having a counter cyclical investment strategy is the best way to build an investment portfolio. What this means is that often when the economy is in a recessionary stage it is easier to purchase properties at a larger discount. Note however that this also tends to be the period where it is hardest to obtain funding as banks and other lenders tend to tighten their criteria considerably through this period. Investors who have a history of repaying principal rather than just staying on interest only have a higher chance of getting funding in the tough times.
 
While everyone is at different stages of their lives in regards to both age and investing experience, what we often recommend is to look to structure the mortgages in such a way that:
 
  • You adopt a split banking strategy (see our One Bank Trap eBook for more info) and look to put the investment properties on interest only
  • We then recommend calculating what the mortgage payments would be as if all mortgage debt was on principal and interest, you can then deduct what the investment mortgage interest only payments are from this figure and then direct whatever is left over towards the principal on your own residence. If you can be disciplined we recommend directing the surplus into a revolving credit facility which be used for future deposits and renovation funds for future purchases or otherwise can be built up as a safety buffer. This strategy has the benefits of being better from an asset protection point of view as you are building more equity in your own home which shouldn’t be cross secured into the investments and also allows for a buffer as you can always reduce the payments to the revolving credit facility if cashflow gets tight.

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Kris Pedersen Mortgages Limited
+64 9 486 4719
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