Interest-only home loan
With interest-only home loans, only the interest on the loan is paid each month - not the capital borrowed. At the end of the loan term (for example, 25 years), a landlord would owe the lender the amount borrowed, and if they wanted to keep the property, they would need to have a plan on how to repay the original loan.
Many landlords choose to borrow money to invest in property with an interest-only home loan, with an intention to sell at the end of the term. At this point, they will pay any tax due on capital gains and retain any equity. It's worth noting that the interest-only portion of the home loan is tax deductible.
Principal and interest
Principal and interest home loans will cost more each month.
The repayment amount is made up of the interest on the loan and paying back a portion of the amount borrowed.
Over time, as more and more of the original loan is paid off, the principal and interest amount reduces as the borrower’s equity increases. The repayments are structured so that at the end of the term, both the interest and the full amount borrowed are paid off entirely. The property is then owned outright.
To decide which loan option is suitable for you and whether a home loan interest or principal and interest loan is the right choice, you will need to be clear on your investment objectives and take into consideration the tax implications of investing in property to let.
Mortgage interest and tax
When you own a property and rent it out, you're essentially running a business. As such, there are certain costs that are tax deductible, and one of these are interest payments.
Most landlords who want to maximise their rental income and the return on their property investment consider the tax benefits, choosing to invest with some level of mortgage over the long-term.
What are your property investment objectives?
With an interest-only home loan, a landlord would keep more of their monthly income but never pay off the loan. With a principal and interest mortgage, the landlord owns the property outright at the end of the term. However, for those who are investing to generate an income, the interest-only home loan option may be best.
If it's capital growth and a lump sum that interests you most, or you want to pass on a fully owned asset to your beneficiaries, a principal and interest mortgage may prove to be the right choice for you.
Contact one of our specialist brokers to determine whether you should choose a repayment or interest-only home loan for property investment.