Making the Switch from Interest-Only to Principle & Interest Finance
In light of strict regulations from the Australian Prudential Lending Authority (APRA), loans have been met with tougher terms, shorter loan periods and higher interest rates. Interest-only loans in particular have felt the full force of these changes.
Traditionally, over the past 20 years or so, Interest-Only (IO) finance has been the preferred option to maximise borrowing power and tax deductibility, however investors are now more keen on signing up for Principal & Interest (P & I) loans that offer more competitive terms and the ability to reduce the loan principle. It is also worth considering that P & I loans for property investment will, in many cases, only result in a nominal increase in monthly repayments.
Investors are increasingly mindful that they cannot rely solely on capital growth to build equity, and refinancing to a P & I loan may hold the key for many to get the most out of their investments. An example of this is below:
Investor: A Fly-In-Fly-Out Worker with a loan about to expire on one of three investment properties. After being shown the competitive terms available in switching all three to P & I, the equity-building capabilities boost future borrowing power. For only an additional $10 per month, he is able to reduce the principle on a $400,000 loan. The difference in payments on his three loans when compared with P & I are outlined in the following table:
| $400k | Previous Bank | IO @ 5.69% | $1897 p/m | |
| New Bank | P&I @ 3.99% | $1907 p/m | Extra $10 p/m | |
| $385k | Previous Bank | IO @ 4.75% | $1524 p/m | |
| New Bank | P&I @ 3.83% | $1800 p/m | Extra $276 p/m | |
| $375k | Previous Bank | IO @ 5.11% | $1597 p/m | |
| New Bank | P&I @ 3.83% | $1754 p/m | Extra $157 p/m |
Although attitudes towards borrowing for property investment are changing, many investors still understand debt can be useful for asset wealth accumulation. It is important to realise though that one should never take on debt purely on the basis of interest-only payments just because it is slightly easier to repay in the short term. The affordability of an investment should always be assessed with an accountant, and on the basis of P & I terms.
Due to APRA’s tougher regulations, most lenders now break down their rates based on purpose and repayment type. This results in four separate interest rate brackets – the lowest being owner occupied P & I loans; then owner occupied interest-only finance; followed by investment P & I; and finally the highest being investment interest-only. Another consideration when looking at interest-only loans is that lenders also enforce stricter serviceability calculations for interest-only loans, reducing payment terms from 30 years to 25, which ultimately results in higher monthly payments and potentially lower borrowing power.
Making any investment or loan moves should always be undertaken with the assistance of professionals. Get in touch with McKinley Plowman today for access to a team of finance brokers, property specialists and accountants that can make the borrowing process simpler, and potentially more successful.