There is often confusion over interest only vs. principal & interest loans and what is the best to sign up to. While nothing that I write here is to be taken as any more then my opinions (i.e. I am NOT offering financial advice), I can offer the following for your consideration.
People often express concern that with an interest only loan they “will never pay down the debt” .
Exactly!
Let me ask you a question…
When you deposit money into a bank what are you actually doing? You are “playing bank” and they become the borrower. Do banks pay you interest only or do they offer to pay back principal? Of course they have to give you back your principal when you request it… but my point is that they never offer to. If you were to leave your money in the bank and never withdraw it, they would happily pay you interest “forever”… while they leverage on your money to create wealth for their shareholders.
Suffice to say that if it is good enough for a bank to use other peoples money and pay interest only… in order to create wealth; then I consider it worthy of my consideration too!
When people buy a home to live in they are doing just that. They want to own the dirt, the bricks and so on. When I “buy” an investment property, however, do I want the same? Not necessarily. My goal is ownership of the increased value of the new asset (rather than the asset itself) than I am now able to manage as a result of leverage… using “other peoples money”!
Think of property as windmills. If it is my “principal windmill of residence”, then I want to own that thing… and I hope it appreciates as well. BUT AS AN INVESTOR I don’t care who owns the windmill (or who lives in it; within reason – you know what I mean)… I just want to own the rights to the output; that is… the energy or the electricity.
So, because I am now…
- Not trying to pay off the “windmill”
- Collecting rent from the person living in it
- Receiving a tax refund for providing “public windmills”
… I can afford more than one – probably more than two! Now… when the wind blows I will own the wealth from the sale of the energy/electricity from all my windmills (instead of just the one) . You see the value of this increase in energy output is far more valuable than the small amount of principal that I may have been able to pay off, had that been my strategy.
Put simply, if I take my available cashflow and pay the principal component of a loan (as well as interest) I will reach my maximum borrowing capacity sooner and will afford less property (as well as reduce the tax refund that holding that property entitles me to) .
When my friendly bank manager loans me the money required to settle an investment property purchase there will be a condition of (normally) just 5 years at “interest only”, after which the loan will revert to principal & interest. Most astute investors I know will ask their bank for another 5 years and if they say “no”, take their business elsewhere. Well they don’t normally need to do this… just threaten to!
As I said I am not offering financial advice, nor should you take anything I have written as such. Please give due consideration, however, to how you structure your investment finances and what you do at the end of your 5 year “interest only” period. Getting these things right can make all the difference to your wealth… when the next (property) wind blows your way!
Happy Investing,
Nick Lockhart
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