Despite the benefits of interest-only loans for investors, the regulatory measures imposed on investors and these loans mean that principal and interest loans are being considered more and more.
According to the RBA, about
two-thirds of interest-only (IO) loans are set for expiration by 2020.
During this time and over the next three years, $120 billion worth of interest-only loans will roll over to principal and interest (P&I) loans. What would this shift look like, and will it change the investing landscape?
Some lenders are finding IO loans more and more of a risk to lend out, and as such are placing more scrutiny on those who apply for them.
In comparison, P&I loans have less scrutiny and can improve an investor’s chances of securing finance.
However, while borrowers would be paying less interest, the principal part would result in an increase of approximately $7,000 per year on an average $400,000 loan.
How can investors moving from an IO loan prepare for P&I? Here are a few ideas that you can take on so you are prepared for the change.
- Save additional money
By anticipating the move to pay off an overall higher loan, borrowers can save themselves some trouble by saving money to pay more off.
“Many borrowers make provisions ahead of time for the rise in required repayments. It is common for borrowers to build up savings in the form of offset accounts, redraw balances or other assets. They can draw upon these to cover the increase in scheduled payments or reduce their debt.”
2. Use the Interest Only period to make additional payments
This is by far and above my preferred strategy. Most people don’t realise you can make Principle payments on an Interest Only loan. This means you can make additional payments on when you choose to.
But the affect is that you reduce your overall borrowing amount, so when the interest rates rise or more importantly when you IO period expires, the overall monthly repayments calculated mainly on the remaining principle has been reduced.
3. Refinance the loan
Borrowers also have the option of refinancing their home loan for an investment property to an IO loan, or enter into a new, longer P&I loan, which can reduce the cost of required payments.
“Any such refinancing will reduce the demands on a borrower’s cash flows for a time. However, it is worth noting that by further delaying regular principal repayments, eventually those repayments will be larger than otherwise.”
4. Sell a property
A final scenario, if a loan is unmanageable, is borrowers could also sell a property in order to repay it, but this situation is one that investors are not facing as much as owner-occupiers are.
Remember that the purpose of an investment is to HELP your lifestyle. It’s to add value to what you enjoy. Any investment that drains you, causes you financial stress is really one that you should ask yourself “Why do I even own this?”
The IO to P&I changes could be the catalyst needed to ‘remove your deadwood’.