If you are living in your property there are usually no tax benefits, or any benefits, of having a loan outstanding. In this case the aim should be to pay off the loan as quickly as possible so that the money that was paying for the loan can be used for another wealth generating investment.
If the loan is for an "investment" property, then there are a number of good reasons to maintain the loan on the property as high as possible, for as long as possible.
This seems to be opposite to what most expatriate investors do. That is to put as big a deposit down as possible and then use their higher earnings to pay the mortgage off as soon as possible.
We believe it is best to separate the interest payment from the loan repayment for several reasons. So an interest only loan should be backed with a savings plan or a lump sum investment to serve as a repayment vehicle.
There are several potential benefits of an interest only loan combined with a saving plan or lump sum investment compared to a repayment mortgage.
1. Monthly payments may be lower
An interest only loan backed with an investment plan to repay the mortgage at the end of the term will usually result in lower monthly payments than a repayment mortgage, which obviously helps with cash flow. This is especially true now with interest rates at very low levels.
2. There may be tax benefits, especially if the property is rented out
There may be a tax benefit to paying interest on a mortgage for properties that are rented out. With the principal outstanding during the entire life of the loan, the opportunities for reducing taxes with interest payments remain, in contrast to the reduced tax advantages over time for the repayment method, as shown in the two graphs below.
The linear interest payments of the interest only loan continue throughout the life of the loan to offset rental income throughout the loan term. The continual tax benefit is especially desirable if your total income is expected to rise over time.
3. Interest only loans result in a lower financial commitment
In the event you are faced with a temporary disruption to your income or cash flow for whatever reason, such as vacancy in an investment property, unemployment, illness or any other circumstance that means reduced cash flow to pay a property loan or loans in the short term, you are much better off with a combination of an interest only loan and a savings plan because you can take a holiday from contributions into the savings plan until normal cash flow has resumed, which would reduce your immediate payment obligations by 30% to over 50% depending on the rates and terms of your loan due to the lower payments to the bank with an interest only loan. This could be a very important difference in the event of unforeseen difficulties as it helps you to buy time.
4. You can diversify your assets if they are heavily biased towards properties
Using the investment plan to diversify into other assets reduces the risk of your whole portfolio if your portfolio is heavily biased towards property, which has seen strong appreciation in recent years. If property prices are to fall, your portfolio would be directly affected. With a more diversified portfolio, the negative impact on your net worth would be less in such an event.
5. Interest only loans allow you to maximise the benefit from today's lower interest rates
The lower the interest rates are, the more attractive an interest only loan is. If money were free to borrow, you quite likely would want to borrow as much as you could. Conversely, if rates were very high, say 25% or 30%, you would likely not want to borrow much at all if you could help it. Currently rates are generally low by historical standards, which is an incentive to borrow and maximises the benefits of interest only loans.
6. Savings plan or lump sum repayment vehicles are portable
Another benefit from backing the loan with an investment is portability. The investment stays with the investor and is not tied to the property in the event of a sale, enabling the investor to purchase another, using the investment to back the new property loan.
If you would like to learn more about P&I and Interest Only Mortgages contact us here.
In order to determine the best solution for you, meet with one of our advisers, who will asses your current situation, or issue that you want addressed, and will construct an effective affordable solution specially tailored to fit your needs.