Interest only a must have feature of your investment loan

Many investors are so caught up with researching the investment market to find a property they believe will show a good return that they forget about the benefits derived when they also check out the investment loan market with equal diligence.

By far the majority of investors simply approach their bank when looking for an investment loan and accept the suggestions of the bank manager or mobile consultant without giving it a second thought. Rather than taking this route, which may be easy and convenient, the astute investor will check out the investment loan options available in the market before committing to the first investment loan suggested to him or her.

By researching the investment loan properly an investor will soon discover that it is not just the interest rate on a mortgage that can deliver cost savings and consequently a better overall return on the investment property. While most Australians have a mindset of paying down principal on a home loan so that over a 25 or 30 year term the debt is repaid in full – this approach is not appropriate for an investment loan situation.

The difference between your home loan and an investment loan is that the interest that is paid on the latter facility is tax deductible. The interest on the investment loan (as well as other maintenance and real estate agency costs) is generally deductible against the rental income you receive on the investment property. If the investment loan interest plus these other costs exceed the rental income then you have a shortfall or loss on that investment. That shortfall or loss is deductible against you personal income so that if for example you earn $60,000 p.a. from paid employment and you have a loss of $5000 on your property investment (having paid investment loan interest etc) then your taxable income will reduce to $55,000 p.a. and the tax payable will be re-calculated against that reduced income. This is what is commonly known as negative gearing on an investment.

Because, unlike home loan debt, the interest on an investment loan is tax deductible it is preferable to leave the principal debt as it is as opposed to paying it down by way of principal and interest instalments over the life of the loan (as you would normally do for a home loan facility). By not making any principal repayments on the investment loan you achieve a two-fold benefit:

1.       you maximise the amount of deductible interest on your investment loan (the interest on your investment loan does not reduce because you are not reducing the principal amount).

2.       you conserve the money you would otherwise be applying to the investment loan to use to either repay your home loan non-deductible debt or save for the purchase or other personal items e.g. a car, refrigerator etc) rather than taking a lease or purchasing on your credit card – in both instances you will be paying a relatively high interest rate and the interest repayments will not be deductible against your income.

As a general rule any investment loan should be taken on an interest only basis and any surplus cash that results from this interest only investment loan structure should be applied to repay non-deductible personal loans or put aside as savings for future personal use.