Are Interest-Only Loans Now Dead?

There was a time when property owners were advised that their investment loans should be interest-only and the loan on their own home should be principal and interest.  But now some experts think that borrowers should radically change their loan structure.

The logic used to be that, as home owners were paying their home loan with after-tax dollars, they should focus on reducing this debt as a priority.  Whereas, as the interest on investment loans is tax deductible, borrowers did not need to prioritise paying down these loans.

Now, some believe that both owner-occupied and investment loans should be Principal and Interest (P&I).

The reason being that, due to pressure from the banking regulator, interest rates on P&I loans are now significantly lower than interest-only.

As a result, recent research has shown that the average basic investor variable loan is sitting at 4.87 per cent – some 0.56 per cent higher than the average owner-occupied principal and interest loan.

Some Standard Variable Loans are now as high as 5.8 per cent.

As a result, for some, it may now be more cost-effective turning all loans into P&I to enjoy the benefit of sharper rates.

And these spreads are likely to get larger.  This week Bankwest announced that it was increasing its interest-only loans by up to 0.35 per cent, while it was reducing some P&I loans by 0.15 per cent.

And with some lenders offering two-year P&I fixed loans at 3.88 per cent, there are some great incentives to start paying everything off.

One argument for keeping some loans interest-only was because it improved cash flow.  But, now that P&I rates are so much sharper, borrowers may actually be better-off paying the principal down too.  For example, if we compare a $400,000 4.21 per cent P&I investment loan versus a 5.8 per cent interest-only investment loan, the monthly repayments would be:

$1,864 (P&I)

$1,933 (i/o)

You can see above that the making payments P&I has a better impact on the client’s hip pocket.

Origin Finance has access to powerful software which can easily calculate the implications of converting your loan to P&I; call us today and get a loan health check.

Note

This article is general in nature and does not constitute advice.  Once you have spoken with your broker, you should also speak to your financial advisor and/or accountant to establish what is the best strategy for your own situation.