With this week’s column, if your eyes glaze over after the second paragraph I certainly won’t be offended.
It’s about whether you should have a principal and interest loan or an interest only loan. I know..yawn. However if you are fortunate enough have a prime residence (your home) and an investment property and happen to have mortgages on both then it’s important that you have your loans correctly set up.
For those that are not in this situation you can now move on to the next article! For those still with me and not sure what I’m talking about, a principal and interest loan is when your monthly loan repayment pays off the interest that is due that month plus some of the money that you originally borrowed (the principal). Whereas with an interest only loan you just pay the interest, resulting in a lower monthly repayment but not reducing the loan or principal amount.
If your lender gives you a choice, you should consider a principal and interest loan for your home and an interest only loan for your investment property.
The reason for this is that you should be focusing all your excess cash on paying down home loan. This is because your home loan is not tax deductible whereas your investment property loan is. You need to stop renting your home from the bank as soon as possible. The principal amount on the property investment is much less important. If you have bought correctly your investment will go up in value over time and your equity increases as it does. There is actually a strong argument for putting as little of your hard earned in as possible. Your tenant should be paying the bulk of the repayment and portion you have to put in is tax deductible (negative gearing) but your contribution should kept to a minimum until your prime residence is paid off.
Once this has occurred you can then focus on getting your investment property to a point where it is positively geared. That is, where you don’t need to make any personal contribution to the repayment. You may consider switching back to a principal and interest loan at that point and let your tenant pay the property off for you.
You then go shopping for your next investment and do it all again. If you need a hand shopping we are always happy to help.